Question

Carmichael Company is considering purchasing a piece of equipment for $60,000. It expects the equipment will last 12 years (and will then be worthless) and each year will generate $7,200 net income before taxes. Carmichael’s tax rate is 21%. What would be Carmichael’s expected before-tax cash flow if it purchased this asset?

Answer 1

Answer:

Initial outlay = $60,000

Annual net income before tax = $7,200 per annum

Depreciation = Cost - Residual value

                        Estimated useful life

                      = $60,000 - 0

                           12 years

                     = $5,000 per annum

Annual net cashflow before tax

= Annual net income before tax + Depreciation

= $7,200 + $5,000

= $12,200

Explanation:

In this case, the annual net income before tax has been given. The annual net income before tax has excluded depreciation, which does not involve movement of cash. Therefore, we need to add back depreciation in order to obtain the expected before tax cashflow.