Question

Fairfax Pizza is evaluating a project that would require an initial investment in equipment of 600,000 dollars and that is expected to last for 7 years. MACRS depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 are 39 percent, 32 percent, 20 percent, and 9 percent, respectively. For each year of the project, Fairfax Pizza expects relevant, incremental annual revenue associated with the project to be 1,020,000 dollars and relevant, incremental annual costs associated with the project to be 876,000 dollars. The tax rate is 50 percent. What is (X plus Y) if X is the relevant operating cash flow (OCF) associated with the project expected in year 1 of the project and Y is the relevant OCF associated with the project expected in year 4 of the project?

Answer 1

relevant operating cash flow (OCF) associated with the project expected in year 1:

incremental annual revenue = $1,020,000

incremental annual costs = $876,000

Less: Depreciation 600,000*39% = 234,000

Income = -$90,000

Tax Savings= $45,000

Income after tax = -45,000

Add: Depreciation(non-cash) 234,000

Cash flow = $189,000

Calculation of Y:

incremental annual revenue = $1,020,000

incremental annual costs = $876,000

Less: Depreciation 600,000*9% = 54,000

Income = $90,000

Tax = $45,000

Income after tax = 45,000

Add: Depreciation(non-cash) 54,000

Cash flow = $99,000

Hence, the answer X+Y = 189,000+99,000

= $288,000