Charles Company owns a building that originally cost $400,000 and has a current book value of $250,000. The building was financed by a loan that has one payment of $20,000 outstanding, which must be paid off upon the sale of the building. Charles Company would like to purchase a new building for $600,000. If the new building is purchased, the existing building would be sold for $380,000. Charles Company’s income tax rate is 40%. If the new building is purchased, the relevant initial cash flows would total

Answer (B) is correct. The relevant initial cash flows total $292,000. The project will require an initial outlay of $600,000 for the new building and an outflow of $20,000 for the loan payment, which must be paid off upon the sale of the building. In order to calculate the after-tax proceeds from disposal of the existing building, first calculate the tax gain or loss, which is equal to a gain of $130,000 ($380,000 disposal value – $250000 book value). The after-tax effect on cash can then be calculated as follows:
$380,000 disposal value – $52,000 ($130,000 gain × 40% tax rate) tax cost on gain = $328,000 after-cash inflow Thus, the total initial cash outflow is equal to $292,000 ($600,000 initial outflow + $20,000 debt outflow – $328 after-tax inflow from sale of old building).