Question

Cash is King Corp. has an investment project that will reduce expenses by $20,000 per year for 3 years. The project's cost is $25,000. If the asset is part of the 3-year MACRS category (33.33% first year depreciation) and the company's tax rate is 36%, what is the cash flow from the project in year 1? (Do not round intermediate calculations. Round your answer to the nearest dollar amount.)

• $15,250

• $16,580

• $17,260

• $15,800

Answer 1

Solution :

The cash flow from a project is calculated using the formula

= [ ( Savings in expenses – Depreciation expense ) * ( 1 – Tax rate ) ] + Depreciation expense

As per the information given in the question we have

Savings in expenses = $ 20,000 ; Project cost = $ 25,000 ; Depreciation rate for Year 1 = 33.33 % ;

Tax rate = 36 % = 0.36 ;

Depreciation expense for year 1 = Project cost * Depreciation rate for Year 1

= $ 25,000 * 33.33 % = $ 8,332.50

Applying the available information in the formula we have

= [ ( $ 20,000 - $ 8,332.50 ) * ( 1 – 0.36 ) ] + $ 8,332.50

= [ ( $ 20,000 - $ 8,332.50 ) * 0.64 ] + $ 8,332.50

= [ $ 11,667.50 * 0.64 ] + $ 8,332.50

= $ 7,467.20 + $ 8,332.50

= $ 15,799.70

= $ 15,800 ( when rounded off to the nearest dollar amount )

Thus the cash flow from the project in year 1 = $ 15,800

The solution is option 4 = $ 15,800