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

Annual cash flow for Year 1 = $ 20,625

Particulars	Amount (in $)
Cash Flow before Depreciation and Taxes	$25,000
Less : Depreciation*	($12,500)*
Cash Flow before Tax	$12,500
Less : Tax at 35%	($4,375)
Cash Flow After Tax	$8,125
Add Back : Depreciation	$12,500
Net Annual Cash Flow	$ 20,625

*Depreciation under straight line method = [ Cost – Salvage Value ] / Useful life

= [ $50,000 – 0 ] / 4 Years

= $12,500 per year