Marie's Fashions is considering a project that will require $28,000 in net working capital and...

Question:

Marie's Fashions is considering a project that will require $28,000 in net working capital and $87,000 in fixed assets. The project is expected to produce annual sales of $75,000 with associated costs of $57,000. The project has a 5-year life. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 30 percent.

What is the operating cash flow for this project?

Operating Cash Flow:

The operating cash flows are the cash provided or used in the normal course of business activities. It is recorded in the statement of cash flows. Examples of operating cash flow activities are cash received from customers and cash paid to suppliers.

Answer and Explanation:

First, we compute the net income of the project.

Annual sales $75,000
Less: Associated costs 57,000
Income before tax 18,000
Multiply: Net of tax rate (100% - 30%) 70%
Net income $12,600

The net income is $12,600.

Next, we compute the depreciation expense.

  • Depreciation expense = Cost in fixed asset / Estimated useful life
  • Depreciation expense = $87,000 / 5 years = $17,400

The depreciation expense $17,400.

To find the operating cash flow, we add the net income and depreciation expense net of income tax. Depreciation expense does not produce cash flow.

  • Operating cash flows = Net income + Depreciation expense x Tax rate
  • Operating cash flows = $12,600 + $17,400 x 30%
  • Operating cash flows = $12,600 + $5,220 = $17,820

The operating cash flow for this project is $17,820.


Learn more about this topic:

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Operating Cash Flow: Definition & Examples

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4
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