Question

A firm is planning to start a new project. The firm spent $45,000 on a market study and $30,000 on consulting three months ago. If the firm starts the project, it will spend $600,000 for new machinery, $50,000 for installation, and $20,000 for shipping. The machine will be depreciated via the 5-year MACRS depreciation method (20.00%, 32.00%, 17.20%, 11.50%, 11.50%, and 5.8%, respectively, from Year 1 to Year 6). The expected sales increase from this new project is $450,000 a year, and the expected incremental expenses are $180,000 a year. In order to start this new project, the company has to invest $100,000 in working capital. The marginal tax rate is 34%. What is the incremental cash flow of this project in Year 2?

A)$220,013

B)$217,382

C)$102,142

D)$224,107

Answer 1

Calculation of cash flow-

Year	Sales increase	Incremental expenses	Depreciation	Taxable income	Tax @34%	Income after tax	Cash flow
1	450000	180000	134000	136000	46240	89760	223760
2	450000	180000	214400	55600	18904	36696	251096
3	450000	180000	115240	154760	52618.4	102141.6	217381.6
4	450000	180000	77050	192950	65603	127347	204397
5	450000	180000	77050	192950	65603	127347	204397
6	450000	180000	38860	231140	78587.6	152552.4	191412.4

Note1 - cash flow has been calculated after adding back depreciation in the income after tax.

Incremental cash flow of this project in year 2 is $217382, so the correct option is B.

Calculation of depereciation-

Year	Cost of Machine	Depreciation rate	Depreciation amount
1	670000	20	134000
2	670000	32	214400
3	670000	17.2	115240
4	670000	11.5	77050
5	670000	11.5	77050
6	670000	5.8	38860