Question

KADS, Incorporated has spent $490,000 on research to develop a new computer game. The firm is planning to spend $290,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated using bonus depreciated; they total $59,000. The machine has an expected life of three years, a $84,000 estimated resale value, and falls under the MACRS seven-year class life. Revenue from the new game is expected to be $690,000 per year, with costs of $340,000 per year. The firm has a tax rate of 21 percent, has an opportunity cost of capital of 12 percent, and expects net working capital to increase by $145,000 at the beginning of the project. What will the cash flows for this project be? Note: Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.

Year 0 1 2 3
FCF ___ ___ ___ ___

Answer 1

To find the cash flows for this project, we need to calculate the net income for each year and then subtract any investments in net working capital and capital expenditures.

In year 0, the firm will incur the following expenses:

- Research and development costs: $490,000

- Cost of the machine: $290,000

- Shipping and installation costs: $59,000

- Increase in net working capital: $145,000

Total expenses in year 0: $490,000 + $290,000 + $59,000 + $145,000 = $984,000

The net income in year 0 is equal to the revenue minus the costs: $690,000 - $340,000 = $350,000.

Therefore, the cash flow in year 0 is:

FCF0 = $350,000 - $984,000 = -$634,000

In years 1, 2, and 3, the firm will incur the following expenses:

- Cost of goods sold: $340,000

- Depreciation: (This can be calculated using the MACRS depreciation schedule. For the first year, the depreciation will be 14.29% of the cost of the machine, or 0.1429 * $290,000 = $41,461. The depreciation in subsequent years can be calculated using the same method.)

- Increase in net working capital: $145,000

Total expenses in each of years 1, 2, and 3: $340,000 + Depreciation + $145,000

The net income in each of these years is equal to the revenue minus the costs: $690,000 - (Total expenses)

The cash flow in each of these years is equal to the net income minus any investments in net working capital and capital expenditures: Net income - Increase in net working capital - Depreciation

Substituting the appropriate values, we get:

Year 1: FCF1 = $690,000 - ($340,000 + $41,461 + $145,000) = $163,539

Year 2: FCF2 = $690,000 - ($340,000 + Depreciation + $145,000)

Year 3: FCF3 = $690,000 - ($340,000 + Depreciation + $145,000)

Note that the depreciation in years 2 and 3 can be calculated using the same method as in year 1.

So, the cash flows for this project are:

Year 0 1 2 3

FCF -$634,000 $163,539

I hope this helps!