Question

Frozen, Inc. spends $750,000 on equipment for a one-year expansion project. For this project, it increases its inventory by $150,000 and accounts payable by $25,000--both are expected to reverse at project completion. The project will be housed in a building Frozen, Inc. purchased seven years ago for $1,500,000. Frozen, Inc.'s tax rate is 50% and cost of capital is 12%. What is the initial outlay (i.e., initial investment, which is a cash outflow) in year 0

Answer 1

$875,000

Step-by-step explanation:

The investment in year 0 is the acquisition cost of the equipment plus the increase in net working capital investment which are both needed to get the project underway:

the acquisition cost of equipment=$750,000

net working capital investment=increase in inventory-increase in payable

net working capital investment=$150,000-$25,000

net working capital investment=$125,000

the initial outlay=$750,000+$125,000

the initial outlay=$875,000

The cost of acquiring the land seven years is not relevant as it is a committed/sunk cost, not a cash outflow required now