Question

14: A firm is evaluating a new capital project. The firm spent $45,000 on a market study and $30,000 on consulting three months ago. If the firm approves the project, it will spend $448,000 on new machinery, $15,000 on installation, and $5,000 on shipping. The machine will be depreciated via simplified straight-line depreciation over its 8-year life. The expected sales increase from this new project is $700,000 a year, and the expected incremental expenses are $250,000 a year. In order to start this new project, the company will invest $100,000 in working capital. The marginal tax rate is 40%. What is the annual net cash flow per year from this project?

$234,900

$293,400

$298,400

$297,150

$292,400

Answer 1

The answer is $293,400.

annual net cash flow per year = [(expected increase in sales - expected increase in expenses - depreciation)*(1-tax rate)] + depreciation

Depreciation is a non-cash expense and generates saving in taxes. so for cash flow calculation, depreciation will first be deducted from sales to get after-tax cash flow and then added back to get net cash flow.

Depreciation = (cost of machinery +  installation cost + shipping cost - salvage value)/life of machinery

Depreciation = ($448,000 + $15,000 + $5,000 - $0)/8 = $468,000‬/8 = $58,500‬

salvage value is zero.

annual net cash flow per year = [($700,000 - $250,000 - $58,500)*(1-0.40)] + $58,500

annual net cash flow per year = ($391,500‬*0.60) + $58,500 = $234,900‬ + $58,500 = $293,400