Question

The firm is considering the purchase of a €200,000 computer-based inventory management system. It will be depreciated straight-line to zero over its four-year life. It will be worth €30,000 at the end of that time. Each year the system will save the firm €60,000 before taxes in inventory-related costs. The relevant tax rate is 30%. Because the new setup is more efficient than the existing one, the firm will be able to carry less total inventory and thus free up €45,000 in net working capital.

a) What is the initial capital spending?

Answer 1

The firm's accounting profit is $50,000, calculated by subtracting total explicit costs from sales revenue. The initial capital spending for the computer-based inventory management system is €155,000, taking into account the system's cost and the release of net working capital.

Step-by-step explanation:

To determine a firm's accounting profit, we subtract the total explicit costs from the total sales revenue. In this case, the firm had sales revenue of $1 million last year. It spent $600,000 on labor, $150,000 on capital, and $200,000 on materials. Therefore, the accounting profit is calculated as follows:

Accounting Profit = Sales Revenue - Labor Costs - Capital Costs - Material Costs

Accounting Profit = $1,000,000 - $600,000 - $150,000 - $200,000

Accounting Profit = $50,000

The initial capital spending for the inventory management system the firm is considering would include the purchase cost of the system and any additional costs related to its acquisition and installation.

Since we are given that the system costs €200,000 and that the firm will free up €45,000 in net working capital, the initial capital spending can be considered the system cost minus the working capital released.

Thus, the initial capital spending would be €200,000 - €45,000 = €155,000.