Problem:
The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $40,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in net operating working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be sold for $25,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent.
Q1. What is the net investment required at t = 0?
Cost 40,000
Change in NWC 2,000
Total 42,000
Q2. What is the operating cash flow in Year 2?
|
Year
|
Percent
|
Basis
|
Depreciation
|
|
1
|
0.33
|
$40,000.00
|
$ 13,200.00
|
|
2
|
0.45
|
$40,000.00
|
$ 18,000.00
|
|
3
|
0.15
|
$40,000.00
|
$ 6,000.00
|
|
4
|
0.07
|
$40,000.00
|
$ 2,800.00
|
|
|
|
|
$ 40,000.00
|
|
|
|
|
|
|
Operating Cash Flows
|
|
|
|
Year 1
|
Year 2
|
|
1
|
Increase in Revenues
|
$20,000.00
|
$ 20,000.00
|
|
2
|
Increase in Costs
|
$ (5,000.00)
|
$ (5,000.00)
|
|
3
|
Before-tax change in earnings
|
$15,000.00
|
$ 15,000.00
|
|
4
|
After-tax change in earnings (line 3 X .60)
|
$ 9,000.00
|
$ 9,000.00
|
|
5
|
Depreciation
|
$13,200.00
|
$ 18,000.00
|
|
6
|
Tax Savings depreciation (Line 6 x .40)
|
$ 5,280.00
|
$ 7,200.00
|
|
7
|
Net Operating Cash Flow's
|
$14,280.00
|
$ 16,200.00
|
|
|
|
|
|
|
Operating Cash Flow in Year 2 is
|
$16,200.00
|
|
What is the total value of the terminal year non-operating cash flows at the end of Year 3?
(Market value - book value)*tax rate .40