3. What are the components of net cash outlay in the capital budgeting decision? Explain clearly the
effects of taxes-ordinary as well as capital gains-on the sale proceeds of an old asset that is being
replaced in determining the initial cash outlay of new asset.
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Explanation:
Jane’s Kitchen sells fresh baked cookies on a busy street. Jane currently uses a single oven, which cannot keep up with the store’s demand. Jane is considering buying a new, better oven that will produce enough cookies to meet the demand. She also decides to sell off her old oven since it will no longer be needed.
The existing oven is currently worth $1,000. Jane negotiates a deal with a smaller bakery to sell them her old oven for its market price of $1,500. The new oven will cost Jane $5,000. In anticipation of increased production, Jane decides to stock up on ingredients and buys $800 worth of flour. Her business’ tax rate is 35%. What is her initial outlay?
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