Question

Hubrey Home Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $4.7 million. The fixed asset falls into Class 10 for tax purposes (CCA rate of 30 percent per year), and at the end of the three years can be sold for a salvage value equal to its UCC. The project is estimated to generate $2,730,000 in annual sales, with costs of $864,000. If the tax rate is 35 percent, what is the OCF for this project? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round your intermediate calculations. Round your answers to 2 decimal places. (e.g., 32.16))

OCF1	$
OCF2	$
OCF3	$

Answer 1

The initial fixed asset investment falls in the CCA Class 10 bracket and hence attracts a depreciation rate of 30%.

Initial Cost = $ 4.7 million

Depreciation Expense for Year 1 = 4.7 x 0.3 = $ 1.41 million

Depreciated Value at the end of Year 1 = (4.7 - 1.41) = $ 3.29 milion

Depreciation Expense for Year 2 = 3.29 x 0.3 = $ 0.987 million

Depreciated Value at the end of Year 2 = 3.29 - 0.987 = $ 2.303 million

Deprciation Expense for Year 3 = 2.303 x 0.3 = $ 0.6909 million

Depreciated Value at the end of Year 3 = (2.303 - .6909) = $ 1.6121 million

OCF (for any year) = (Sales - Costs/Expenses) x (1-Tax Rare) + Tax Rate x Annual Depreciation Expense

Tax Rate = 35 %

OCF1 = (2730000 - 864000) x (1-0.35) + (0.35) x 1410000 = $ 1706400

OCF2 = (2730000 - 864000) x (1-0.35) + (0.35) x 987000 = $ 1558350

OCF3 = (2730000 - 864000) x (1-0.35) + (0.35) x 690900 = $ 1454715

NOTE: No matter what might be said and done, the salvage value (UCC) is never added to the Operating Cash Flow (OCF), as the same is not a part of any firm's cash flows generated by operation. Salvage Value Cash Flow is a part of the firm's Investing Cash Flows.