Question

What is the operating cash flow for year 5 of project A that Green Forest Technology should use in its NPV analysis of the project? The tax rate is 10 percent. During year 5, project A is expected to have relevant revenue of 86,000 dollars, relevant variable costs of 22,000 dollars, and relevant depreciation of 15,000 dollars. In addition, Green Forest Technology would have one source of fixed costs associated with the project A. Yesterday, Green Forest Technology signed a deal with Carl Advertising to develop a marketing campaign. The terms of the deal require Green Forest Technology to pay Carl Advertising either 21,000 dollars in 5 years if project A is pursued or 24,000 dollars in 5 years if project A is not pursued. Finally, the equipment purchased for the project would be sold in 5 years for an expected after-tax cash flow of 14,000 dollars.

Answer 1

As we need to determine the Operating Cash Flow (OCF) of Year 5 for Project A, we can safely assume that the firm indeed pursued the development of the marketing campaign. Therefore, the payout for the marketing campaign is $ 21000.This cost is considered to be equivalent to a fixed cost.

Relevant Revenue = $ 86000

Less: Variable Cost = $ 22000

Less: Fixed Cost = $ 21000

Operating Profit = $ 43000

Less: Depreciation = $ 15000

Earnings Before Tax = $ 28000

Less: Tax @ 10 % = 0.1 x 28000 = $ 2800

Net Income = $ 25200

Add: Depreciation = $ 15000

OCF = $ 40200

NOTE: The proceeds of equipment sale worth $ 14000 DO NOT form a part of the firm's OCF as this cash flow is NOT generated by the firm's regular operations.