Question

# A company is considering a new project. The project will generate \$200,000 in revenues and \$110,000...

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).

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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