Final answer:
The incremental cash flow is the additional cash that occurs from an investment. At year 0, there is an outflow of $1,100,000. For year 1 and subsequent years, the cash flows are calculated by accounting for revenue, cash expenses, tax savings from depreciation, and changes in net working capital.
Step-by-step explanation:
Incremental Cash Flow Calculation
The incremental cash flow is the additional cash that a project generates over its life, considering all inflows and outflows associated with the project. To calculate the incremental cash flow for the given investment, we should consider both the revenue and expenses, along with changes in working capital, depreciation, and taxes.
Year 0
At year 0, the investment of $1,000,000 is made, additional inventory requires $150,000, and accounts payable increases by $50,000. Therefore, the net cash outflow is the sum of the investment and inventory minus the increase in accounts payable.
- Initial Investment: -$1,000,000
- Additional Inventory: -$150,000
- Increase in Accounts Payable: +$50,000
Net Cash Flow (Year 0) = -$1,000,000 - $150,000 + $50,000 = -$1,100,000
Year 1
The net operating cash flow can be calculated by taking the revenue generated and subtracting both the cash expenses and taxes. The taxes are calculated by taking into account the depreciation expense allowed by MACRS and the tax rate of 21%.
Net Operating Cash Flow (Year 1) = Revenue - Cash Expenses - Taxes
Depreciation (1st Year MACRS for 7-year property) = 14.29% of $1,000,000 = $142,900
Net Income before taxes = Revenue - Cash Expenses - Depreciation
Taxes = Tax rate * Net Income before taxes
Net Cash Flow (Year 1) = Revenue - Cash Expenses - Taxes
Year 7
In year 7, we will also consider the last year of MACRS depreciation.
Year 8
As the MACRS depreciation is fully utilized by the end of year 7, cash flows from year 8 onwards would not include depreciation, only accounting for revenue, expenses, and taxes.