Question

LO, Inc., is considering an investment of $447,000 in an asset with an economic life of five years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be $285,800 and $89,400, respectively. Both revenues and expenses will grow thereafter at the annual inflation rate of 5 percent. The company will use the straight-line method to depreciate its asset to zero over five years. The salvage value of the asset is estimated to be $67,000 in nominal terms at that time. The one-time net working capital investment of $21,000 is required immediately and will be recovered at the end of the project. The corporate tax rate is 22 percent. What is the project’s total nominal cash flow from assets for each year?

Answer 1

	0	1	2	3	4	5
Nominal annual cash revenues		$   2,85,800	$    3,00,090	$   3,15,095	$    3,30,849	$   3,47,392
Nominal annual cash expenses		$       89,400	93870	98564	103492	108666
Depreciation [447000/5]		$       89,400	$       89,400	$      89,400	$       89,400	$      89,400
Net operating income		$   1,96,400	$    2,10,690	$   2,25,695	$    2,41,449	$   2,57,992
Tax at 22%		$       43,208	$       46,352	$      49,653	$       53,119	$      56,758
Net operating income after tax		$   1,53,192	$    1,64,338	$   1,76,042	$    1,88,330	$   2,01,234
Add: Depreciation		$       89,400	$       89,400	$      89,400	$       89,400	$      89,400
Operating cash flow		$   2,42,592	$    2,53,738	$   2,65,442	$    2,77,730	$   2,90,634
Initial capital expenditure	$       4,47,000
Increase in NWC	$          21,000
After tax salvage value = 67000*(1-22%) =						$      58,960
Recovery of NWC						$      21,000
Nominal cash flow from assets	$     -4,68,000	$   2,42,592	$    2,53,738	$   2,65,442	$    2,77,730	$   3,70,594