Question

Fool Proof Software is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project's 10-year expected life. What is the Year 1 cash flow?

Equipment cost (depreciable basis)	$48,000
Sales revenues, each year	$60,000
Operating costs (excl. depr.)	$25,000
Tax rate	35.0%

a. $29,426

b. $33,387

c. $28,294

d. $29,709

e. $28,860

Answer 1

The year 1 cash flow is computed as shown below:

= (Sales revenue - operating cost (excl. depr.) - depreciation - tax expenses) + depreciation

Tax expenses is computed as follows:

= (Sales revenue - operating cost (excl. depr.) - depreciation ) x tax rate of 35%

= ($ 60,000 - $ 25,000 - $ 48,000 x 33%) x 35%

= $ 6,706

So, the year 1 cash flow will be as follows:

= ($ 60,000 - $ 25,000 - $ 48,000 x 33% - $ 6,706) + $ 48,000 x 33%

= $ 28,294

So, the correct answer is option c.

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