Question

Heritage Corporation is trying to decide whether to invest in equipment to manufacture a new product. If the investment project is accepted, sales revenue will increase by $65,000 per year and materials costs will decrease by $16,000 per year. The equipment will cost $140,000 and is depreciable over 10 years using simplified straight line (zero salvage value). The firm has a marginal tax rate of 34%. Calculate the firm's annual cash flows resulting from the new project.

Answer 1

Answer:

The firm's annual cash flows resulting from the new project is $58,220

Explanation:

The computation of the firm's annual cash flows is shown below:

1. Add : Sales revenue increased = $65,000 per year

2. Add: Material cost decreased = $16,000 per year

3. Profit before tax = Sales revenue + material cost

                               = $65,000 + $16,000

                               = $81,000

5. Less Tax @ 34% = Profit before tax × tax rate = $81,000 × 34% = $27,540

6. Net income = Profit before tax - tax rate = $81,000 - $27,540 = $53460

7. Add : depreciation rate = Depreciation × marginal rate

                                          = $14,000 × 34% = $4,760

8. Annual cash flow = Net income + depreciation rate

                                   = $53,460 + $4,760 = $58,220

where, depreciation is = (Purchase price - salvage value) ÷ Useful life

                                      = ($140,000 - 0) ÷ 10

                                      =$14,000

The depreciation is a non cash expense, so it is not affect the annual cash flow. That's why we don't considered depreciation in computation part.

Hence, the firm's annual cash flows resulting from the new project is $58,220