Hi...i have a quick doubt in question 2.6 from CMA support packages:
Right-Way Stores is a chain of home improvement stores with 150 locations. Right-Way has
identified an attractive site for a new store and Jim Smith, Director of Financial Planning, has been
asked to prepare an analysis and make a recommendation for or against opening this proposed new
store.
In preparing his analysis, Smith has determined that the land at the proposed site will cost $500,000
and the new store will cost $3.5 million to build. The building contractor requires full payment at
the start of construction, and it will take one year to build the store. Right-Way will finance the
purchase of the land and construction of the new building with a 40-year mortgage. The mortgage
payment will be $118,000 payable annually at year end. Fixtures for the store are estimated to cost
$100,000 and will be expensed. Inventory to stock the store is estimated to cost $100,000.
Concerned about the possibility of rising prices, the company expects to purchase the fixtures and
inventory at the start of construction. Advertising for the grand opening will be $50,000, paid to the
advertising agency on retainer at the start of construction. The new store will begin operations one
year after the start of construction.
Right-Way will depreciate the building over 20 years on a straight-line basis, and is subject to a 35%
tax rate. Right-Way uses a 12% hurdle rate to evaluate projects. The company expects to earn after-
tax operating income from the new store of $1,200,000 per year.
REQUIRED:
1. What is Right-Way's total initial cash outflow? Show your calculations.
Solution:
500000 + 3500000 + 100000 + 100000 + (50000*(1-.35)) = $4232500
Why they have considered tax effect for marketing expenses alone that too in initial cash outflow?
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Shrihari Jayakumar
Other
Chennai TN
India
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