Question

Coache Corporation is considering a capital budgeting project that would require an investment of $360,000 in equipment with a 4 year useful life and zero salvage value. The annual incremental sales would be $630,000 and the annual incremental cash operating expenses would be $410,000. In addition, there would be a one-time renovation expense in year 3 of $43,000. The company’s income tax rate is 30%. The company uses straight-line depreciation on all equipment.

The total cash flow net of income taxes in year 3 is:

Answer 1

Initial Investment = $360,000
Useful Life = 4 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $360,000 / 4
Annual Depreciation = $90,000

Annual Operating Cash Flow = (Annual Sales - Annual Operating Expenses) * (1 - Tax Rate) + Tax Rate * Annual Depreciation
Annual Operating Cash Flow = ($630,000 - $410,000) * (1 - 0.30) + 0.30 * $90,000
Annual Operating Cash Flow = $220,000 * 0.70 + 0.30 * $90,000
Annual Operating Cash Flow = $181,000

Year 3:

Total Cash Flow = Operating Cash Flow - Renovation Expense
Total Cash Flow = $181,000 - $43,000
Total Cash Flow = $138,000