Question

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,550,000. 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 $2,300,000 in annual sales, with costs of $1,290,000.

Required:
If the tax rate is 35 percent, what is the OCF for this project?

Answer 1

The operating cash flow (OCF) for Cochrane, Inc.'s expansion project, after calculating the annual depreciation, operating income, tax adjustments, and adding back the non-cash depreciation expense, comes out to be $1,506,500.

Step-by-step explanation:

To calculate the operating cash flow (OCF) for Cochrane, Inc.'s expansion project, we start by calculating the annual depreciation expense, which is the initial fixed asset investment divided by the project's life. This calculation gives us $2,550,000 / 3 = $850,000 in annual depreciation.

Next, we calculate the operating income by subtracting the costs from the annual sales, resulting in $2,300,000 - $1,290,000 = $1,010,000. We then need to adjust for taxes by applying the tax rate to the operating income, which gives us $1,010,000 x (1 - 35%) = $656,500.

Finally, we add back the non-cash depreciation expense to obtain the OCF. The resulting OCF is $656,500 + $850,000 = $1,506,500.