Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $3 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,180,000 in annual sales, with costs of $855,000. The project requires an initial investment in net working capital of $400,000, and the fixed asset will have a market value of $260,000 at the end of the project. If the tax rate is 30 percent, what is the project’s Year 1 net cash flow? Year 2? Year 3?

Answer 1

Year 1: 1,152,500

Year 2: 1,269,500‬

Year 3: 1,520,500

Step-by-step explanation:

sales revenue 2,180,000

cost of goods sold: (855,000)

gross profit 1,325,000

MACRS IRS table:

Recovery Period Percentage

1st year 25%

2nd year 38%

3rd year 37%

3,000,000 x 25% = 750,000 depreciation expense

income before taxes: 1,325,000 - 750,000 = 575,000

after tax: 575,000 x (1 - 30%) = 402,500 net income

then we adjust adding the depreciation as it doesn't involve a cash payment:

+ 750,000 depreciation expense

cash flow: 1,152,500‬

Year 2:

we can save calculation appling the tax to the gross profit and adding the depreciation tax shield:

MACRS IRS table:

Recovery Period Percentage

1st year 25%

2nd year 38%

3rd year 37%

3,000,000 x 38% = 1,140,000‬ depreciation expense

cash flow for year 2:

1,325,000 x (1-0.30) + 1,140,000 x 0.3

927,500 + 342,000 = 1,269,500‬

Year 3

MACRS IRS table:

Recovery Period Percentage

1st year 25%

2nd year 38%

3rd year 37%

beside the cash flow from operationg we got the release of 260,000 working capital:

gross profit after tax + depreciaiton tax shield + release of working capital

1,325,000 x (1 - 0.3) + 3,000,000 x 0.37 x 0.3 + 260,000

927,500 + 333,000 + 260,000 = 1,520,500‬