Question

A potential new project involves an up-front purchase of equipment that would cost $980. The equipment would be depreciated on a straight-line basis over its 3 year useful life to a $200 book value. The firm's tax rate is 30%. As part of the capital budgeting process, you are asked by your boss to determine the annual net cash flow impact of the asset's depreciation. You should indicate that the cash flow impact per year (in each of years 1 through 3, not the combined amount) will be $__

Answer 1

Cash flow impact per year = $78.00

1. Annual Depreciation = (Cost - Salvage) / Useful Life = 780 / 3 = $260

2. Cash Flow impact from asset depreciation in Year 1 = Annual Depreciation * Tax Rate = $260 * 30% = $78.00

Cash Flow impact from asset depreciation in Year 2 = Annual Depreciation * Tax Rate = $260 * 30% = $78.00

Cash Flow impact from asset depreciation in Year 3 = Annual Depreciation * Tax Rate = $260 * 30% = $78.00

Asset depreciation will result in tax shield and Thus it will result in positive cash flow

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