Question

12-2     a. If Company XYZ plans to launch a new production line, and in year 1, will have sales revenue $10,000,000, operating cost is 70% of the sales revenue, depreciation is $2,000,000, and tax rate is 40%, what is the Company’s projected cash flow in year 1?

b. If the Company’s launch of the new production line will cause the exit of an existing production line that can generate $1,000,000 operating income before tax, how much will be the Company’s projected cash flow in year 1, if we take this opportunity cost or cannibalization into the consideration?   

c. If the tax rate fell to 30%, what will be the project’s cash flow?

Answer 1

a. Cash flow in year 1= (Sales-Operating cost)*(1-tax rate)+ Tax rate*Depreciation

= (10000000-70%*10000000)*(1-40%)+ 40%*2000000

=1800000+ 800000

= 2600000

b.

Cash flow in year 1= (Sales-Operating cost)*(1-tax rate)+ Tax rate*Depreciation - Loss of operating income before tax*(1-tax)

= (10000000-70%*10000000)*(1-40%)+ 40%*2000000 - 1000000*(1-40%)

=1800000+ 800000 -600000

= 2000000

c.

Cash flow in year 1= (Sales-Operating cost)*(1-tax rate)+ Tax rate*Depreciation - Loss of operating income before tax*(1-tax)

= (10000000-70%*10000000)*(1-30%)+ 30%*2000000 - 1000000*(1-30%)

= 2000000