Question

What is the operating cash flow for year 4 of project A that Red Royal Media should use in its NPV analysis of the project? The tax rate is 10 percent. During year 4, project A is expected to have relevant revenue of 84,000 dollars, relevant variable costs of 26,000 dollars, and relevant depreciation of 16,000 dollars. In addition, Red Royal Media would have one source of fixed costs associated with the project A. Yesterday, Red Royal Media signed a deal with Liam Advertising to develop a marketing campaign. The terms of the deal require Red Royal Media to pay Liam Advertising either 26,000 dollars in 4 years if project A is pursued or 31,000 dollars in 4 years if project A is not pursued. Finally, the equipment purchased for the project would be sold in 4 years for an expected after-tax cash flow of 6,000 dollars.

Answer 1

First, we will calculate Net income for year 4 of Project A :-

Relevant revenues : $84,000

Relevant variable cost : $26,000

Cost of marketing campaign : $26,000

Relevant Depreciation : $16,000

Income after depreciation but before taxes : $16,000 { $84,000 - ($26,000 + $26,000 + $16,000) }

Taxes : $1600 ( $16,000 x 0.10)

Net Income after Taxes : $14,400 ( $16,000 - $1600)

Calculating operating cash flows for year 4:-

Net Income : $14,400

Depreciation : $16,000

Sell price ( after-tax) : $6000

Operating Cash flow for year 4 = $14,400 + $16,000 + $6000 = $36,400