Question

Fairfax Pizza is evaluating a project that would require an initial investment in equipment of 300,000 dollars and that is expected to last for 8 years. MACRS depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 are 39 percent, 31 percent, 20 percent, and 10 percent, respectively. For each year of the project, Fairfax Pizza expects relevant, incremental annual revenue associated with the project to be 345,000 dollars and relevant, incremental annual costs associated with the project to be 279,000 dollars. The tax rate is 50 percent. What is (X plus Y) if X is the relevant operating cash flow (OCF) associated with the project expected in year 1 of the project and Y is the relevant OCF associated with the project expected in year 4 of the project?

Answer 1

The Operating Cash Flow can be Computed using the formula:

Relevant Revenue -Relevant Cost -Depreciation -Tax and add back depreciation

Here the Initial Investment =$300,000

The depreciation rate for year 1 is 39% and for year 4 10%

Relevant Revenue =$345,000 per year and Relevant Costs =$279,000

Tax = 50%

Year 1 depreciation =$300,000*39%=117000 Year 4 depreciation =$300,000*10% =$30,000

So Year 1 Operating Cash flow(X) =$345.000-$279,000-$117,000+25,500(-51,000*50%)(tax refund) +117000=$91,500

Year 4 Operating Cash Flow(Y)=$345,000-$279,000-$30,000-18,000(36,000*50%)+$30,000=$48,000

So X+Y =$91,500+$48,000=$139,500