Question

Green Forest Entertainment is evaluating a project that would require the purchase of a piece of equipment for 780,000 dollars today. During year 1, the project is expected to have relevant revenue of 664,100 dollars, relevant costs of 338,900 dollars, and relevant depreciation of 80,000 dollars. Green Forest Entertainment would need to borrow 780,000 today for the equipment and would need to make an interest payment of 29,300 dollars to the bank in 1 year. Relevant operating cash flow for the project in year 1 is expected to be 239,306 dollars. What is the tax rate expected to be in year 1? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

Solution:

The Operating Cash Flow is calculated using the formula

= [ ( Revenue – Costs – Depreciation – Interest payment ) * ( 1 – Tax Rate ) ] + Depreciation

As per the Information given in the question we have

Revenue = $ 664,100   ; Costs = $ 338,900   ;   Depreciation = $ 80,000 ;

Interest payment = $ 29,300 ; Operating Cash Flow = $ 239,306   ; Let the Tax Rate be = “ x “ ;

Thus applying the above information in the formula we have

$ 239,306 = [ ( $ 664,100 - $ 338,900 - $ 80,000 - $ 29,300 ) * ( 1 – x ) ] + $ 80,000

$ 239,306 - $ 80,000 = [ ( $ 664,100 - $ 338,900 - $ 80,000 - $ 29,300 ) * ( 1 – x ) ]

$ 159,306 = $ 215,900 * ( 1 – x )

$ 159,306 / $ 215,900 = ( 1 – x)

0.737869 = 1 – x

x = 1 – 0.737869

x = 0.262131

x = 0.2621 ( when rounded off to four decimal places )

Thus the tax rate expected to be in Year 1 is = 0.2621