Question

15. Rick Barr Inc. is considering a new product line that has expected sales of $500,000 per year for each of the next 5 years. New equipment that is required to produce the new product will cost $800,000. The equipment has a useful life of 5 years and an $80,000 salvage value and will be sold at the end of year 5 for its salvage value. Total variable costs of the product line are $230,000 per year, total fixed costs (not including depreciation) will be an additional $100,000 per year and the initial working capital investment, to buy inventory, will be $10,000. The discount rate (interest rate) for the project is 10% and the company’s tax rate is 35%. What is the total cash flow of year 5 for the company? A. $250,900 B. $160,900 C. $240,900 D. $256,750

Answer 1

Answer: A.) $250,900

Explanation:

Given the following ;

Working Capital = $10,000

Salvage value = $80,000

Cost of equipment = 800,000

Tax rate = 35%

Number of useful years = 5 years

The formula for cash flow is = EBIT * (1 - tax rate) + Depreciation + Salvage Value + Working Capital released

Depreciation = (cost - Salvage value) ÷ Number of useful years

Depreciation = $(800,000 - 80,000)/5

Depreciation = $720,000÷5 = $144,000

EBIT = Sales - Variable costs - Fixed costs - Depreciation

EBIT = $500,000 - $230,000 - $100,000 - $144,000

EBIT = $26,000

Cash flow = $26,000(1 - 0.35) +$144,000 + $80,000 + $10,000

Cashflow = $250,900