finance: Project Cash Flows

Question

Steamboat Springs Furniture, Inc., is considering purchasing a new finishing lathe that costs $55,624.00. The lathe will generate revenues of $96,772.00 per year for five years. The cost of materials and labor needed to generate these revenues will total $50,601.00 per year, and other cash expenses will be $11,136.00 per year. The machine is expected to sell for $9,839.00 at the end of its five-year life and will be depreciated on a straight-line basis over five years to zero. Steamboat Springs' marginal tax rate is 38.00 percent, and its cost of capital is 12.00 percent.

What is the project cash flow for the last year of the project? (HINT: Add project cash flow plus the terminal value)

Answer Format: Currency: Round to: 2 decimal places.

Answer 1

First let's calculate depreciation expense because we'll need that to compute the last year's operating cash flow. Straight line depreciation equals (historical cost - estimated salvage value) / useful life. In this case, it is (55,624 - 0) / 5 = 11,124.80 per year.

Next let's calculate earnings before interest and taxes (EBIT).

EBIT = Revenue - Expenses (including depreciation)

EBIT = 96,772 - 50,601 - 11,136 - 11,124.8

EBIT = 23,910.20

Now let's calculate net operating profit after tax (NOPAT)

NOPAT = EBIT * (1-tax rate)

NOPAT = 23,910.20 * (1-.38)

NOPAT = 14,824.32

Now let's calculate Operating Cash Flow (OCF)

OCF = NOPAT + Depreciation

OCF = 14,824.32 + 11,124.80

OCF = 25,949.12

This is the annual project cash flow. However, in the last year it turns out you can sell the finishing lathe. So we need to include an after tax salvage value.

After tax salvage value = Salvage - (Salvage - Book Value) * Tax Rate

Note that we depreciated the equipment to 0 so the Book Value = 0

After tax salvage value = 9,839 - (9,839 - 0)*.38

After tax salvage value = 6,100.18

So the project cash flow in the last year is 25,949.12 + 6,100.18 = $32,049.30

Hope that helped!