Question

You are considering a new project whose data are shown below. The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year 1 cash flow? Equipment cost (depreciable basis) $65,000 Sales revenues, each year $60,000 Operating costs (excl. depreciation) $25,000 Tax rate 35.0%

Answer 1

The depreciable basis of the equipment is $65,000, and it has a 3-year tax life, which means the annual depreciation expense is $65,000 / 3 = $21,666.67.

The operating costs, excluding depreciation, are $25,000 per year.

The sales revenue is $60,000 per year.

The taxable income for Year 1 is calculated as follows:
Taxable income = Sales revenue - Operating costs - Depreciation expense
Taxable income = $60,000 - $25,000 - $21,666.67
Taxable income = $13,333.33

The income tax for Year 1 is calculated as follows:
Income tax = Taxable income x Tax rate
Income tax = $13,333.33 x 35.0%
Income tax = $4,666.67

The Year 1 cash flow is calculated as follows:
Year 1 cash flow = Sales revenue - Operating costs - Depreciation expense - Income tax
Year 1 cash flow = $60,000 - $25,000 - $21,666.67 - $4,666.67
Year 1 cash flow = $8,666.66

Therefore, the project's Year 1 cash flow is $8,666.66.