Question

7. (CMA) Garfield Inc. is considering a 10-year capital investment project with forecasted cash revenues of $40,000 per year and forecasted cash operating costs of $29,000 per year. The initial cost of the equipment for the project is $23,000, and Garfield expects to sell the equipment for $9,000 at the end of the tenth year. The equipment will be depreciated on a straight-line basis over seven years for tax purposes. The project requires a working capital investment of $7,000 at its inception and another $5,000 at the end of year 5. The working capital is fully recoverable at the end of the life of the project. Assuming a 40% tax rate, expected net after-tax cash flow from the project for the tenth year is:

a.$32,000.

b.$24,000.

c.$20,000.

d.$11,000.

e.$12,000.

Answer 1

Answer- Expected net after-tax cash flow from the project for the tenth year is = $24000.

Explanation-

Recurring after-tax operating cash flow (excluding the depreciation effect)	($40000-$29000)*(1-.40)	$6600
After-tax cash flow from terminal disposal of equipment	($9000 - $Nil book value)*(1 – 0.40)	$5400
Working capital recovered	($7000+$5000)	$12000
Net after-tax cash inflow for year 10		$24000

Where- No tax savings from depreciation for the tenth year because the equipment is already fully depreciated at the end of year 7.