Question

The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new machine. The machine's price is $40,000, and it falls into the MACRS 3-year class. Purchase of the machine would require an increase in net operating working capital of $2,000. The computer would increase the firm's before-tax revenues by $25,000 per year but would also increase operating costs by $19,000 per year. The machine is expected to be used for 3 years and then be sold for $12,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent. What is the operating cash flow in Year 2? Round it to a whole dollar, and do not include the $ sign.

Answer 1

Operating cash flow in Year 2

Increase in Revenue = $25,000 per year

Increase in Cost = $19,000 per year

Depreciation Expense for Year 2 = $5,924 [$40,000 x 14.81%]

Therefore, the Operating Cash Flow = [(Increase in Revenue – Increase in Cost) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($25,000 - $19,000) x (1 – 0.40)] + [$5,924 x 0.40]

= [$6,000 x 0.60] + [$5,924 x 0.40]

= $3,600 + $2,370

= $5,970

“Hence, the Operating cash flow in Year 2 will be $5,970”