Question

A firm is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. The project would also reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax rate?

A) $2.4 million
B) $3.4 million
C) $4.6 million
D) $5.0 million

Answer 1

To calculate the free cash flow on the project, subtract the expenses and reduction in cash revenues from the total revenue, and account for the tax rate.

Step-by-step explanation:

To calculate the free cash flow on the project, we need to subtract the cash expenses, depreciation expenses, and the reduction in cash revenues from the total revenue. Then, we need to account for the tax rate. Here's how:

Total revenue: $12 million

Cash expenses: $5 million

Depreciation expenses: $1 million

Reduction in cash revenues: $2 million

Free cash flow before taxes: $12 million - $5 million - $1 million - $2 million = $4 million

Tax rate: 40%

Free cash flow after taxes: $4 million - ($4 million * 0.4) = $2.4 million

Therefore, the free cash flow on the project, per year, is $2.4 million. Option A is the correct answer.