Question

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,490,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,280,000 in annual sales, with costs of $1,270,000.

Required: If the tax rate is 30 percent, what is the OCF (Operating Cash Flow) for this project?
A) $435,000
B) $420,000
C) $455,000
D) $465,000

Answer 1

The fixed asset investment for Cochrane, Inc.'s three-year expansion project is $2,490,000. The project is estimated to generate $2,280,000 in annual sales with costs of $1,270,000. We need to calculate the net present value (NPV) to determine the viability of the project.

Step-by-step explanation:

The fixed asset investment for Cochrane, Inc.'s three-year expansion project is $2,490,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,280,000 in annual sales, with costs of $1,270,000.

To calculate the net annual cash flows, we subtract the costs from the sales:

1. Year 1: $2,280,000 - $1,270,000 = $1,010,000
2. Year 2: $2,280,000 - $1,270,000 = $1,010,000
3. Year 3: $2,280,000 - $1,270,000 = $1,010,000

To calculate the net present value (NPV) of the project, we discount the cash flows at the firm's required rate of return. Let's assume the required rate of return is 10%:

NPV = Year 1 Cash Flow / (1 + r)^1 + Year 2 Cash Flow / (1 + r)^2 + Year 3 Cash Flow / (1 + r)^3 - Initial Investment

NPV = $1,010,000 / (1 + 0.10)^1 + $1,010,000 / (1 + 0.10)^2 + $1,010,000 / (1 + 0.10)^3 - $2,490,000

Calculate the NPV to find the answer to the question.