Question

KADS, INC has spent $400,000 on research to develop a new computer game. The firm is planning to spend $200,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated using bonus depreciation:they total $50,000. The machine has an expected life of three years and a $75,000 estimated resale value. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will cash flows for this project be?

Answer 1

Total Initial Cost = Research cost+ machine cost+shipping & installation cost+ change in Working capital = 400000+200000+50000+100000=$750000

Depreciable Amount = Total cost-working capital-bonus depreciation-salvage value=750000-100000-50000-75000=$525000

Annual Depreciation = 525000/3 =$175000

Depreciation for year 1=Original depreciation+bonus depreciation=175000+50000=$225000

Annual Gross Profit =Revenue- Cost = 600000-250000=$350000

Profit before tax Year 1 = Gross Profit-Depreciation = 350000-225000=$125000

Profit before tax Year 2 & 3 = Gross Profit-Depreciation = 350000-175000=$175000

Profit After Tax Year 1= Profit before tax*(1-Tax Rate) = 125000*(1-21%) = 125000*0.79 = $98750

Profit After Tax Year 2= Profit before tax*(1-Tax Rate) = 175000*(1-21%) = 175000*0.79 = $138250

Cashflow Year 0=-$750000

Cashflow Year 1=Profit after tax+Depreciation=98750+225000=$323750

Cashflow Year 2=Profit after tax+Depreciation=138250+175000=$313250

Cashflow Year 3=Profit after tax+Depreciation+Salvage VAlue+ Release of Working capital= 138250+175000+75000+100000=$488250