Leamon Corporation is considering a capital budgeting project that would require an investment of $240,000 in equipment with a 4 year useful life and zero salvage value. The annual incremental sales would be $630,000 and the annual incremental cash operating expenses would be $480,000. In addition, there would be a one-time renovation expense in year 3 of $40,000. The company's income tax rate is 35%. The company uses straight-line depreciation on all equipment. The total cash flow net of income taxes in year 3 is:
A)$92,500
B)$110,000
C)$78,500
D)$118,500

Question

Quizplus · Accepted Answer

To find the net cash flow in year 3, we need to calculate the following:
- Depreciation expense (which will be the same amount for each year): $240,000 ÷ 4 = $60,000 per year
- Incremental sales: $630,000
- Incremental cash operating expenses: $480,000
- Renovation expense (one-time): $40,000

First, we need to calculate the taxable income for year 3:
Incremental sales - Incremental cash operating expenses - Depreciation expense - Renovation expense = $630,000 - $480,000 - $60,000 - $40,000 = $50,000

Next, we need to calculate the income tax liability:
Taxable income * Tax rate = $50,000 * 0.35 = $17,500

Finally, we can calculate the net cash flow:
Incremental sales - Incremental cash operating expenses - Depreciation expense - Renovation expense - Income tax liability = $630,000 - $480,000 - $60,000 - $40,000 - $17,500 = $32,500

However, we need to remember that this is the net cash flow after deducting income taxes. To calculate the total cash flow net of income taxes, we need to add back the income tax liability:
$32,500 + $17,500 = $50,000

Therefore, the total cash flow net of income taxes in year 3 is $92,500 (not $50,000). The correct answer is A).

Leamon Corporation Is Considering a Capital Budgeting Project That Would