A project will reduce costs by $34,000 but increase depreciation by $16,500. What is the operating cash flow of this project based on the tax shield approach if the tax rate is 40 percent?
Operating Cash Flow:
Operating cash flow measures the cash flow generated from normal business operations and it is calculated as the difference between cash generated from customers minus cash paid to suppliers. Investors use operating cash flow to evaluate the financial outlook of a company by finding whether a company is generating sufficient cash flow to sustain its operations and allow capital expansion without borrowing.
Answer and Explanation:
The correct answer is E
The cash flow generated as a result of reduced cost is determined as follows.
- Cash flow = $34,000 (1 - Tax rate)
- Cash flow = $34,000 (1 - 0.4)
- Cash flow = $20,400
Cash flow generated as a result of the increase in depreciation is calculated as follows
- Cash flow = $16,500 * Tax rate
- Cash flow = $16,500 * 0.4
- Cash flow = $6,600
The operating cash flow generated as a result of the tax shield is determined as follows.
- Operating cash flow = Cash flow from reduced cost + Cash flow from depreciation savings
- Operating cash flow = $20,400 + $6,600
- Operating cash flow = $27,000
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from Finance 101: Principles of FinanceChapter 10 / Lesson 4