Question

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

Answer 1

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