Question

# 14: A firm is evaluating a new capital project. The firm spent \$45,000 on a market...

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

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

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