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Your company has spent $210,000 on research to develop a new computer game. The firm is planning...

Question:

Your company has spent $210,000 on research to develop a new computer game. The firm is planning to spend $41,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $5,100. The machine has an expected life of 5 years, a $26,000 estimated resale value, and falls under the MACRS 7-Year class life. Revenue from the new game is expected to be $310,000 per year, with costs of $110,000 per year. The firm has a tax rate of 30 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $51,000 at the beginning of the project.

What will be the net cash flow for year one of this project?

Cash Flows in Capital Budgeting

Cash Inflows each year is one of the most important variables in capital budgeting. It is calculated to measure the inflows from the project. It is then discounted to find the present value and used in several capital budgeting methods pre discounting and post discounting

Answer and Explanation:

The Machine is purchased in Year 0,

So Year 1 or the 2nd year Depreciation rate as per MACRS schedule of 7 years is 24.49%

Total cost of the asset = 41000 + 5100 = $ 46,100.00

The 2nd year cash flows are hence:

Revenues = 310000

Less: Costs = 110000

Less: Depreciation = 46100 x 24.49% = 11289.89

Earnings before taxes = $ 188,710.11

Tax @ 30% = $ 56,613.03

Earnings after taxes = $ 132,097.077

Add: Depreciation = 11289.89

Cash Flow after tax for Year 1 = $ 143,386.97


Learn more about this topic:

What Is Capital Budgeting? - Techniques, Analysis & Examples

from Corporate Finance: Help & Review

Chapter 3 / Lesson 13
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