Question

A proposed expansion project is expected to increase sales by $87,000 and increase cash expenses by $42,000. The project will require $54,000 of fixed assets that will be depreciated using straight-line depreciation to a zero book value over the five-year life of the project. The store has a marginal tax rate of 26 percent. What is the operating cash flow of the project using the tax shield approach? Ignore bonus depreciation.

Answer 1

OK, here are the steps to solve this:

* Projected sales increase: $87,000

* Projected cash expense increase: $42,000

* So projected operating income increase = $87,000 - $42,000 = $45,000

* Fixed assets required = $54,000

* Depreciation period = 5 years

* So annual depreciation = $54,000 / 5 = $10,800

* Marginal tax rate = 26%

* Tax shield from depreciation = $10,800 * (1 - 0.26) = $7,920

* Operating cash flow (using tax shield approach)

= $45,000 + $7,920 = $52,920

So the operating cash flow of the project using the tax shield approach is $52,920

Let me know if you have any other questions!