Question

XYZ Company is considering whether a project requiring the purchase of new equipment is worth investing. The cost of a new machine is $340,000 including shipping and installation. The project will increase annual revenues by $400,000 and annual costs by $100,000. The machine will be depreciated via straight-line depreciation for three years to a salvage value of $40,000. If the firm does this project, $30,000 in net working capital will be required. What is the annual cash flow of this project in the second year if the tax rate is 40%? Round to the nearest penny. Do not include a dollar sign in your answer.

Answer 1

Cost of Machine = $340,000
Salvage Value = $40,000
Useful Life = 3 years

Annual Depreciation = (Cost of Machine - Salvage Value) / Useful Life
Annual Depreciation = ($340,000 - $40,000) / 3
Annual Depreciation = $100,000

Annual Revenues = $400,000
Annual Costs = $100,000

Annual OCF = (Revenues - Costs) * (1 - tax) + tax * Depreciation
Annual OCF = ($400,000 - $100,000) * (1 - 0.40) + 0.40 * $100,000
Annual OCF = $300,000 * 0.60 + 0.40 * $100,000
Annual OCF = $220,000

Year 2:

Annual Cash Flow = Annual OCF
Annual Cash Flow = $220,000