Question

King Nothing is evaluating a new 6-year project that will have annual sales of $475,000 and costs of $323,000. The project will require fixed assets of $575,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 40 percent. What is the operating cash flow for Year 3?

Answer 1

Solution :

The Operating Cash Flow is calculated using the formula

= [ ( Annual Sales – Annual Costs ) * ( 1 – Tax Rate ) ] + ( Annual Depreciation * Tax Rate )

As per the Information given in the question

Annual Sales = $ 475,000   ;     Annual Costs = $ 323,000     ;      Tax Rate = 40 % = 0.40

MACRS Depreciation Percentage for Year 3 = 19.20 % ; Fixed Assets = $ 575,000

Thus Depreciation for Year 3 = Fixed Assets * MACRS Depreciation Percentage for Year 3

= $ 575,000 * 19.20 %

= $ 110,400

Thus the Annual Depreciation for Year 3 = $ 110,400

Thus applying the above information in the formula we have the operating cash flow for Year 3 as

= [ ( $ 475,000 - $ 323,000 ) * ( 1 – 0.40 ) ] + ( $ 110,400 * 0.40 )

= [ ( $ 152,000 ) * ( 1 – 0.40 ) ] + ( $ 110,400 * 0.40 )

= [ $ 152,000 * 0.60 ] + ( $ 110,400 * 0.40 )

= $ 91,200 + $ 44,160

= $ 135,360

Thus the Operating Cash Flow for Year 3 = $ 135,360