Question

A company is considering a new project. The project will generate $200,000 in revenues and $110,000 in operating costs each year for the next 5 years. It would require an additional investment of $150,000 to be depreciated to a zero book value on a straight line basis over 5 years. The investment has a salvage value of $20,000. The tax rate is 40%. At the end of year 5, there is a $10,000 return of networking capital. Determine the annual cash flows (from years 1 through 4, and on year 5).

Answer #1

ANNUAL CASH FLOW THROUGH YEAR1 to 4

Annual Depreciation =150000/5=$30,000

Tax Rate =40%

Annual Depreciation Tax Shield =30000*40%=$12,000..................(a)

Annual Revenues=$200000

Annual Operating Costs=$110000

Before tax Earning (Excluding Depreciation)=200000-110000=$90,000

After tax Earning (Excluding Depreciation)=90000*(1-0.4)=$54,000.................(b)

Annual Operating Cash Flow=(a)+(b)=12000+54000=$66,000

ANNUAL CASH FLOW THROUGH YEAR1 to 4=$66,000

CASH FLOW IN YEAR 5

Annual Cash Flow=$66,000.............(c)

Pre tax Salvage Value=$20,000

After tax salvage value=20000*(1-0.4)=$12,000............(d)

Return of networking capital=$10,000.................(e)

CASH FLOW IN YEAR 5=(c)+(d)+(e)=66000+12000+10000=$88,000

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