The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $40,000, and it falls into the
MACRS 3-year class. Purchase of the computer would require an increase in net working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be sold for
$25,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent. What is the net investment required at t = 0?
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A. B. C. D. E.D
Initial investment:
Cost($40,000)
Change in NWC(2,000)
($42,000)
To calculate the net investment required at t = 0, we need to consider the initial cost of the computer and the increase in net working capital.
The initial cost of the computer is given as $40,000.
The increase in net working capital is $2,000.
To find the net investment required at t = 0, we need to subtract the salvage value of the computer at the end of its useful life from the initial cost, and also take into account the increase in net working capital. The salvage value is the amount the computer is expected to be sold for at the end of 3 years, which is $25,000.
So, the net investment required at t = 0 can be calculated as follows:
Net Investment = Initial Cost - Salvage Value + Increase in Net Working Capital
Net Investment = $40,000 - $25,000 + $2,000
Net Investment = $17,000 + $2,000
Net Investment = $19,000
However, the above calculation is done before considering the tax effects.
To calculate the net investment required at t = 0 after considering the tax effects, we need to multiply the net investment by (1 - tax rate). The tax rate is given as 40%.
Net Investment after Tax Effects = Net Investment * (1 - Tax Rate)
Net Investment after Tax Effects = $19,000 * (1 - 0.40)
Net Investment after Tax Effects = $19,000 * 0.60
Net Investment after Tax Effects = $11,400
Since the net investment after tax effects is a negative amount (indicating an outflow of funds), the correct answer is:
A. -$36,600
Therefore, the net investment required at t = 0 is -$36,600.