First we will address the 12.2M that James believes is spent so far. We believe this number came from adding up the funds spent on research and development (10.2M), production equipment (1.455M), and preliminary advertising efforts (.545M). These are all costs to consider, but because CTI will not be able to recoup any of the money spent on R&D or preliminary advertising no matter if they reject or pursue the project, so these costs shouldn’t be calculated into the initial outlays. The production equipment category should be included in James’ initial outlay, however, 1.455M is not the true cost because if CTI chooses not to go through with the project, some of this original cost can be recovered by selling off the equipment. If CTI rejects the project the equipment will be sold off and these proceeds will lower the cost of the equipment for CTI to .61M. .61M should be the only final cost in the initial outlay.
James correctly included all of the relevant costs that CTI still must spend if they choose to pursue the project, however, the costs must be broken up into 2 groups. The costs are broken into two groups because they represent two different types of expenses. The first group of expenses is nondepreciable expenses, which just means that as soon as we buy the asset it loses all of its value in accounting. Because this purchase will create a one-time expense and the expense will lower profits, it means CTI will have to pay less in taxes. The savings from paying less in taxes means that the purchase of this first group of assets effectively costs us less than what the initial check is written for. The second group of costs is depreciable expenses. This means that CTI can spread the expense out over a number of years, so instead of a one-time expense that decreases profits and lowers taxes, like the first group, profits will be lower for years 1-10. Like in group 1, because the profits are lower, CTI will pay less in taxes saving them money in the future. This future saved money also lowers the cost of the depreciable assets to below what the initial check was written for. On top of the money CTI saves in taxes, at the end of the project CTI can sell the second group of assets back into the market. The money CTI receives by reselling the assets also helps
