A 4-year project has an annual operating cash flow of $58,000. At the beginning of the project, $4,900 in net working capital was required, which will be recovered at the end of the project. The firm also spent $23,700 on equipment to start the project. This equipment will have a book value of $5,180 at the end of the project, but can be sold for $6,060. The tax rate is 35 percent. What is the Year 4 cash flow?
Answered on
Let's break down the Year 4 cash flow by considering the information provided:
- Operating cash flow per year: $58,000
- Net working capital recovery: $4,900
- Equipment cost: $23,700
- Salvage value of equipment: $6,060
- Book value of equipment: $5,180
The formula to calculate the cash flow in Year 4 is:
Year 4 Cash Flow = Operating Cash Flow + Net working capital recovery + After-tax Salvage Value − Tax on Salvage Value
First, calculate the after-tax salvage value:
After-tax Salvage Value = Salvage Value −Tax on Book Value
The tax on book value is the difference between the book value and the salvage value, multiplied by the tax rate:
Tax on Book Value = (Book Value − Salvage Value) × Tax Rate
Tax on Book Value = ($5,180 - $6,060) \times 0.35 = (-$880) / 0.35 = -$308
After-tax Salvage Value = $6,060 - (-$308) = $6,368
Now, compute the Year 4 cash flow:
Year 4 Cash Flow = $58,000 + $4,900 + $6,368 - (-$308)
Year 4 Cash Flow = $58,000 + $4,900 + $6,368 + $308 = $69,576
Therefore, the Year 4 cash flow is $69,576.