Question

"Explorer, Inc. is considering a new 4-year project that requires an initial fixed asset (equipment) investment of $200,000. The fixed asset is three-year MACRS property for tax purposes. In four years, the equipment will be worth about half of what we paid for it. The project is estimated to generate $500,000 in annual sales, with costs of $400,000. The firm has to invest $100,000 in net working capital at the start. After that, net working capital requirements will be 25 percent of sales. The tax rate is 40 percent. What is the incremental cash flow in year 4?"

		"$65,928 "
		"$71,848 "
		"$125,928 "
		"$250,928 "
		"$290,928

Answer 1

Operating cash flow (OCF) each year = income after tax + depreciation - investment in working capital

In year 4, the entire working capital investment is recovered, and hence the investment in working capital is negative

profit on sale of equipment at end of year 4 = sale price - book value

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value - tax on profit on sale of equipment

Incremental cash flow in year 4 = $250,928