Question

Fortune Company is considering a 3-year project with an initial cost of $594,000. The project will not directly produce any sales but will reduce operating costs by $153,000 a year. The equipment is classified as MACRS 7-year property. The MACRS table values are .1429, .2449, .1749, .1249, .0893, .0892, .0893, and .0446 for Years 1 to 8, respectively. At the end of the project, the equipment will be sold for an estimated $288,000. The tax rate is 25 percent and the required return is 12 percent. An extra $44,500 of inventory will be required for the life of the project. What is the total cash flow for Year 3?

Answer 1

Initial Investment = $594,000
Useful Life = 3 years

Depreciation Year 1 = 0.1429 * $594,000
Depreciation Year 1 = $84,882.60

Depreciation Year 2 = 0.2449 * $594,000
Depreciation Year 2 = $145,470.60

Depreciation Year 3 = 0.1749 * $594,000
Depreciation Year 3 = $103,890.60

Book Value at the end of Year 3 = $594,000 - $84,882.60 - $145,470.60 - $103,890.60
Book Value at the end of Year 3 = $259,756.20

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $288,000 - ($288,000 - $259,756.20) * 0.25
After-tax Salvage Value = $280,939.05

Initial Investment in NWC = $44,500

Year 3:

Operating Cash Flow = Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $153,000 * (1 - 0.25) + 0.25 * $103,890.60
Operating Cash Flow = $140,722.65

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $140,722.65 + $44,500 + $280,939.05
Net Cash Flows = $466,161.70