| Premier Steel, Inc. is considering the purchase of a new machine for $100,000 that has a useful life of 3 years. The firm’s cost of capital is 11% and the tax rate is 40%. This machine will be sold for its salvage value of $20,000 at the end of 3-years. The machine will require an investment of $2,500 in spare parts inventory upon installation. The machine will cost $8,000 to ship and $4,000 to install and modify it. Sales are as follows: year 1 = $90,000; year 2 = $97,500; year 3 = $105,000. Operating expenses are year 1 = $25,000; year 2 = $27,000; year 3 = $29,000. The investment in working capital will be liquidated at termination of the project at the end of year 3. What is the free cash flow for year 3? | ||||
| Year1 | Year2 | Year3 | Year4 | |
| MACRS Rates | 33% | 45% | 15% | 7% |
| A) | $54,820 |
| B) | $52,320 |
| C) | $49,820 |
| D) | $35,520 |
| Calculation of free cash flow: | |
| Sales | 105,000 |
| Operating Expenses | 29,000 |
| Depreciation | 16,800 |
| Income before tax | 59,200 |
| Less: Tax | 23,680 |
| Net Income | 35,520 |
| Add: Depreciation | 16,800 |
| Operating cash flow | 52,320 |
| Recovery of Working capital | 2,500 |
| Free cash flow in year 3 | 54,820 |
| i.e. A |
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