Question

Sam Corp. is considering the purchase of new equipment whose data are shown below. This equipment should be used with tool X the firm now owns, and if this equipment is not purchased, the tool X would be sold for $15,000. What is the project’s Year 0 cash flow? Equipment cost $60,000, Increase in NOWC $15,000, Tax rate 35%

a) -$75,000
b) -$60,000
c) -$45,000
d) -$30,000

Answer 1

Sam Corp.'s Year 0 cash flow for the purchase of new equipment is calculated by adding the equipment cost to the increase in net working capital. Since the sale of tool X is not happening due to the equipment purchase, its potential proceeds are not included in the calculation. The total Year 0 cash flow is thus -$75,000.

Step-by-step explanation:

The project’s Year 0 cash flow for Sam Corp. includes the cost of the new equipment and the increase in net working capital (NOWC), as well as the proceeds from selling the existing tool X if the equipment is not purchased. To determine the initial cash flow outlay, we would subtract any inflows from the total costs (outflows).

The calculation is as follows:

• Cost of new equipment: -$60,000
• Increase in NOWC: -$15,000
• Proceeds from sale of tool X: +$15,000

However, since the equipment purchase is occurring, the sale of tool X will not be realized. Therefore, it is excluded from the Year 0 cash flow calculation.

Total Year 0 cash flow = Equipment cost + Increase in NOWC

Total Year 0 cash flow = -$60,000 (Cost of equipment) + -$15,000 (Increase in NOWC)

Total Year 0 cash flow = -$75,000

Thus, the correct answer is a) -$75,000.