The B. Bowden Company is evaluating the purchase of a new stadium, the B.B. Dome. The new stadium would cost Bowden $100,000,000 and would be depreciated for tax purposes
Using straight-line depreciation over 20 years. It is expected that the new stadium will
Increase revenues by $400,000,000 a year and cash expenses by $200,000,000 a year. Calculate
The incremental annual cash flows if B. Bowden undertakes the stadium project Assume a
Marginal tax rate of 35%.

Question

Quizplus · Accepted Answer

The incremental annual cash flows can be calculated as follows:

Revenue increase: $400,000,000
Less: Cash expenses increase: $200,000,000
Equals: Pre-tax incremental income: $200,000,000

Assuming a marginal tax rate of 35%, the after-tax incremental income can be calculated as:

Pre-tax incremental income: $200,000,000
Less: Tax at 35%: $70,000,000
Equals: After-tax incremental income: $130,000,000

The depreciation expense for the new stadium can also be taken into account for tax purposes as follows:

Depreciation expense per year: $100,000,000 / 20 = $5,000,000

Tax savings due to depreciation expense: $5,000,000 x 35% = $1,750,000

Adding the tax savings to the after-tax incremental income gives us the incremental annual cash flow:

After-tax incremental income: $130,000,000
Plus: Tax savings due to depreciation expense: $1,750,000
Equals: Incremental annual cash flow: $131,750,000

Therefore, the correct answer is C. The incremental annual cash flows can be calculated as follows:

Increase in Revenues = $400,000,000

Less: Increase in Cash Expenses = ($200,000,000)

Less: Depreciation Expense = ($100,000,000 / 20) = ($5,000,000)

Taxable Income = $195,000,000

Less: Tax at 35% = ($68,250,000)

Incremental Annual Cash Flow = $126,750,000

Therefore, the incremental annual cash flows would be $147,500,000 [$126,750,000 / (1 - 0.35)].

Option (C) is the correct answer.

The B Bowden Company Is Evaluating the Purchase of a New