Question

Santo Automotive is considering producing a new automobile product, No Text, which disengages the ability to text while driving. Marketing data indicate that the company will be able to sell 40,000 units per year at $16 each. The product will be produced in a section of an existing factory that is currently not in use. To produce No Text, Santo must buy a machine that costs $820,000. The machine has an expected life of five years and will have an ending residual value of $50,000. Santo will depreciate the machine over five years using the straight-line method. In addition to the cost of the machine, the company will incur incremental annual manufacturing costs of $390,000. The income tax rate is 30% and the company’s required rate of return is 10%. How much is net operating cash flow each year?

		$67,200
		$221,200
		$175,000
		$250,000

Answer 1

Net operating cash flow each year is calculated as follows:

Depreciation = (Cost - Salvage Value) / Useful Life

= ($820,000 - $50,000) / 5 Years

= $154,000

	$
Sales Revenue (40,000 units * $16)	640,000
Annual manufacturing costs	(390,000)
Depreciation	(154,000)
Net Income before tax	96,000
Income Tax (30%)	( 28,800)
Net Income	$67,200

Net operating cash flow each year = Net Income + Depreciation

= $67,200 + $154,000

= $221,200

So correct answer is option (2) or $221,200