Question

Monocle Corporation is considering an investment in equipment for $50,000. Data related to the investment is as follows:

	Cash Flow before
Year	Depreciation and Taxes
1	$ 25,000
2	25,000
3	25,000
4	25,000

Monocle uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 35 percent and the life of the equipment is four years with no salvage value. Cost of capital is 12 percent. What is the annual cash flow for Year 1?

Answer 1

As a result of the investment the Company would generate a cash flow of $25,000

The depreciation expense of $50,000/4 years = $12,500. This is not a cash flow, however, it would provide a tax benefit(lower taxes paid) of 12,500 X 35% = 4,375

The Company's Annual tax expense would be 25,000 X 35% - 4,375 = 4,375

Hence the cash flow net of taxes for year 1 would be 25,000 - 4,375 = $20,625

Addition Info:

The NPV of the project can be computed as

-50,000 + 20,625/(1+12%) + 20,625/(1+12%)² + 20,625/(1+12%)³ + 20,625/(1+12%)⁴ =12,645.33