Question

1. Whatcom Co. is evaluating a project which will generate sales of $50,000 each year with a production cost of $30,000. The project will cost $100,000 and be depreciated straight line to a zero book value over the 10 year life of the project. The applicable tax rate is 36 percent. What is the first year's operating cash flow for this project?

2. Whidbey Inc. purchased some fixed assets three years ago at a cost of $20,000 and these assets are classified as 5-year property for MACRS. Since they no longer need these assets , they decide to sell them today at a price of $35,000. What is the current book value of these assets, i.e. the undepreciated amount at the time of the sale?

                                    MACRS 5-year property

                                    Year                 Rate

                                       1                   20.00%

                                       2                   32.00%

                                       3                   19.20%

                                       4                   11.52%

                                       5                   11.52%

                                       6                   5.76%

Answer 1

(1): Operating cash flow = EBIT + Depreciation – Tax

Annual depreciation = $100,000/10 years = $10,000 per year

	Year 1
Sales	50,000
less: production cost	30,000
less: depreciation	10,000
EBIT	10,000
Tax @ 36% on EBIT	3,600
Net income	6,400

Thus operating cash flow = 10,000 + 10,000 - 3,600

= $16,400

(2): Here depreciation for 3 years will be applicable:

	Depreciation
Year 1	20% of 20,000	=	4,000
Year 2	32% of 20,000	=	6,400
Year 3	19.2% of 20,000	=	3,840
		Total depreciation	14,240

Thus book value = purchase price - accumulated or total depreciation

= 20,000 - 14,240

= $5,760