Question

Clemson Software is 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) $65,000Straight-line depreciation rate 33.333%Sales revenues, each year $60,000Operating costs (excl. depreciation) $25,000Tax rate 35.0%a. $28,115b. $28,836c. $29,575d. $30,333e. $31,092

Answer 1

Answer:

Option (D) is correct.

Explanation:

Here:

Sales = 60,000

Depreciation = 65,000 ÷ 3

                      = 21,667

operating costs = 25,000

Taxable income  = Sales - deprecation - operating cost

                           = $60,000 - $21,667 - $25,000

                           = $13,333  

Net income =  Taxable income × (1 - tax rate)

                    = $13,333 x (1- 0.35)

                    = $8666.45

Cash flow = Net income + deprecation

                = $8666.45 + $21,667

                = $30,333.45

A note: we add back depreciation in cash because its a Non-cash expense. That means it depresses taxable income (thus lowers taxes) but the cash from the deprecation expense DOES NOT come out of the company.