Question

Etonic Inc. is considering an investment of $369,000 in an asset with an economic life of 5 years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be $249,000 and $74,000, respectively. Both revenues and expenses will grow thereafter at the annual inflation rate of 2 percent. Etonic will use the straight-line method to depreciate its asset to zero over five years. The salvage value of the asset is estimated to be $49,000 in nominal terms at that time. The one-time net working capital investment of $12,000 is required immediately and will be recovered at the end of the project. All corporate cash flows are subject to a 39 percent tax rate. What is the project’s total nominal cash flow from assets for each year?

Answer 1

annual increase in revenues = $249,000 - $74,000 = $175,000

then they grow by 2% per year

depreciable value = $369,000 - $49,000 = $320,000

depreciation expense per year = $320,000 / 5 = $64,000

initial investment = $369,000 + $12,000 = $381,000

corporate tax rate = 39%

cash flow year 0 = -$381,000

cash flow year 1 = [($175,000 - $64,000) x (1 - 39%)] + $64,000 = $131,710

cash flow year 2 = [($178,500 - $64,000) x (1 - 39%)] + $64,000 = $133,845

cash flow year 3 = [($182,070 - $64,000) x (1 - 39%)] + $64,000 = $136,023

cash flow year 4 = [($189,426 - $64,000) x (1 - 39%)] + $64,000 = $140,510

cash flow year 5 = [($193,214 - $64,000) x (1 - 39%)] + $64,000 + $49,000 + $12,000 = $203,821