Question

Firm A’s new project needs $325,000 for new fixed assets (long term assets), $160,000 for additional inventory and $35,000 for additional accounts receivable. This is a five year project. Use straight line depreciation approach to calculate the depreciation expenses. By the end of the fifth year, the value of the fixed assets = 0. However, the market value of the assets = 25% of their original cost. At the end of the project, the net working capitals tend to return to its original level. Annual sales is expected to be $600,000 and costs = $450,000. The tax rate = 35%. Required rate of return = 15%.

1. What is the initial cost of this project?

$520,000

2. What is the operating cash flows from year 1 to year 4

$120,250

3. What is the operating cash flows in year 5 (last year)

$386,063

Answer 1

Initial cost = Cost of fixed assets + Investment in working capital

= 325000+160,000+35000

= $520,000

Operating cash flow from Year 1 to 4 = (Sales – costs – Depreciation)(1-Tax rate) + Depreciation (since non-cash expense)

= (600,000-450,000 – 325000/5)(1-35%) + 65000

= $120,250

Additional cash flow in year = After tax salvage value of equipment + Recovery of working capital

= 325000*25%*(1-35%) + 195000

= $247,812.5

Hence, total cash flow in year 5 = $386,062.5