Inventory to stock the store is estimated to cost

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$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. 2. Calculate the annual expected cash flow from the proposed new store. Show your calculations. 3. Right-Way management evaluates new stores over a five-year horizon as management believes there is too much uncertainty after 5 years of operation. Calculate the Net Present Value (NPV) for the store for the first 5 years of operation. Show your calculations. 4. Based solely on your answer to C, would you recommend that Right-Way build this store? Explain your answer. 5. How would you use sensitivity analysis to test your confidence in the recommendation? No calculations are required.
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361 Question 2.17 – Hi-Quality Productions Amy Kimbell was recently hired as an accounting manager for Hi-Quality Productions Inc., a publicly-held company producing components for the automotive industry. One division, Alpha, uses a highly automated process that had been outsourced for a number of years because the capital investment required was high and the technology was constantly changing. Two years ago, the company decided to make the necessary capital investment and bring the operation in house. Since all major capital investments must be approved by the Board of Directors, the budget committee for the Alpha Division recommended the $4 million investment to the Board, projecting a significant cost savings. In her new job as accounting manager, Kimbell is on the budget committee for the Alpha Division. The Board has requested from the committee a post-audit review of the actual cost savings. While working on the review, Kimball noted that several of the projections in the original proposal were very aggressive, including an unusually high salvage value and an excessively long useful life. If more realistic projections had been used, Kimbell doubts that the Board would have approved the investment. When Kimbell expressed her concerns at the next meeting of Alpha’s budget committee, she was told that it had been the unanimous decision of the committee to recommend the investment because it was thought to be in the best long-term interest of the company. According to the committee members, the post-audit report would not discuss these issues; the committee members believe that certain adjustments to the review are justified to ensure the success of the Alpha division and the company as a whole.
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