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; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS 7-year class life. 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 21percent, 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 the cash flows for this projects be?

Answer 1

The Net cash flows are as below

Year	Initial cash flow	OCF	Working capital	Salvage	Net cash flows
0	-250000		-100000		-350000
1		$284,002.25			284002.25
2		$289,357.25			289357.25
3		$285,682.25	100000	82208.25	467890.5

NOTES:

Amount spent on research will be ignored since it is sunk cost. Initial capital = 200000+50000=250000.

First we will compute the Operating cash flows

OCF		MACRS 7 year
Year	Cash flows	Depreciation	EBIT	Tax	PAT	OCF
1	350000	-35725	314275	-65997.75	248277.25	284002.3
2	350000	-61225	288775	-60642.75	228132.25	289357.3
3	350000	-43725	306275	-64317.75	241957.25	285682.3

Salvage
Purchase price	250000
Less: Depreciation	-140675
Closing book value	109325
Selling price	75000
Gain/(loss)	-34325
Tax/ Saving	7208.25
Net salvage	82208.25

WORKINGS