Question

Kinston Limited is considering investing in new equipment that will cost 126000 dollars and will last for three years. The equipment will be fully depreciated using the straight-line method. The equipment will generate revenues of 114000 dollars each year and the cost of goods sold will be 50% of sales. At the end of year three, the equipment will be sold for 15000 dollars. The appropriate cost of capital is 10% and Kinston’s tax rate is 35%.

What is the free cash flow in the final year (i.e., free cash flows in year three)? (Round your final answer to the nearest dollar if needed)

Note: For all the calculation questions, you are only allowed to write the numerical answer you calculated for the question, please DO NOT add $, %, dollars, million, thousand, percent, space, etc. in your answers.

Answer:

Answer 1

Sales in third year = 114000

Cost of goods sold = 114000 * 0.50 = 57000

Depreciation in 3rd year = 126000 / 3 = 42000

Depreciation tax shield in 3rd year = 42000 * 35% = 14700

Profit on sale of equipment = 15000 - 0 = 15000

Tax on profit on sale of equipment = 15000 * 35% = 5250

Free cash flow in Year 3 = (Sales - Cost) * (1 - Tax rate) + Depreciation tax shield + Profit on sale of equipment - Tax on profit

= (114000 - 57000) * (1 - 0.35) + 14700 + 15000 - 5250

= 61500