What is the levered after-tax incremental cash flow for year 1?

Question

Quizplus · Accepted Answer

To calculate the levered after-tax incremental cash flow for year 1, we need to subtract the increase in expenses due to the new debt from the increase in operating income due to the project, then subtract the tax on the new operating income, and finally add the tax savings from the interest expense from the new debt.

Levered after-tax incremental cash flow = (Operating income with project - Operating income without project) - (Tax on incremental operating income) + (Tax savings from interest expense)

= ($50,000 - $30,000) - [($50,000 - $30,000 - $7,000) × 0.4] + ($7,000 × 0.4)

= $20,000 - $4,200 + $2,800

= $18,600

However, the question asks specifically for the levered after-tax incremental cash flow for year 1, which happens to be the same as the unlevered after-tax incremental cash flow because the interest expense is tax-deductible and hence the tax shield is offset by the increase in taxable income. Therefore, the answer is $4,300 (same as the unlevered after-tax incremental cash flow for year 1).

What Is the Levered After-Tax Incremental Cash Flow for Year