Question

A company is looking to purchase and replace a fixed asset for $245,000. It will sell the asset that will be replaced for $46,000 but will incur a $20,000 gain upon that sale. It must also commit $30,000 of working-capital to the investment. The firm's tax rate is 35%. What is the amount of the relevant initial investment?

A. $206,000
B. $236,000
C. $245,000
D. $254,000

Answer 1

The amount of the relevant initial investment is $236,000, which includes the purchase price of the new asset, net proceeds from selling the old asset, and the additional working capital required, after adjusting for taxes on the asset gain.

Step-by-step explanation:

The relevant initial investment for the company is calculated by considering the purchase price of the new asset, the after-tax proceeds from the sale of the old asset, and the additional working capital required. The purchase of the new asset will cost the company $245,000. When selling the old asset for $46,000 with a gain of $20,000, the firm must pay taxes on that gain. The tax on the gain is calculated as 35% of $20,000, which equals $7,000. Therefore, the net proceeds from the sale after taxes will be $46,000 - $7,000 = $39,000.

Now, adding the $30,000 of committed working capital to the purchase price and subtracting the net proceeds from the sale of the old asset, we get: $245,000 + $30,000 - $39,000 = $236,000. This is the total initial investment needed, so the correct answer is B. $236,000.