Operating Cash Flow: Premier Steel, Inc. is considering the purchase of a new machine for $100,000 that has a useful life of 3 years. The firm's cost of capital is 11.0% and the tax rate is 40%. This machine will be sold for its salvage value of $20,000 at the end of 3-years. The machine will require an investment of $2,500 in spare parts inventory upon installation. The machine will cost $8,000 to ship and $4,000 to install and modify it.
Sales are as follows: year 1 = $90,000; year 2 = $97,500; year 3 = $105,000. Operating expenses are year 1 = $25,000; year 2 = $27,000; year 3 = $29,000. The investment in working capital will be liquidated at termination of the project at the end of year 3.
MACRS Rates 33% 45% 15% 7%
Using MACRS, what is the operating cash flow in year 1?

Question

Quizplus · Accepted Answer

To calculate the Operating Cash Flow (OCF) for Year 1, we need to first calculate the Depreciation Expense using MACRS depreciation method.

Year 1 Depreciation Expense = $100,000 x 33% = $33,000

Next, we need to calculate Earnings Before Interest and Taxes (EBIT).

EBIT = Sales - Operating Expenses - Depreciation Expense 
     = $90,000 - $25,000 - $33,000
     = $32,000

Next, we need to calculate the Taxes.

Taxes = EBIT x Tax Rate 
      = $32,000 x 40%
      = $12,800

Finally, we can calculate the Operating Cash Flow (OCF).

OCF = EBIT + Depreciation Expense - Taxes
    = $32,000 + $33,000 - $12,800
    = $52,200

However, we also need to take into account the initial investment in spare parts inventory, shipping and installation costs.

Initial Investment = $2,500 + $8,000 + $4,000
                   = $14,500

Therefore, the Operating Cash Flow (OCF) for Year 1 is:

OCF = $52,200 - $14,500
    = $37,700

The closest option to this answer is A) $53,784, which is incorrect. Therefore, the best choice is A) with the explanation that the OCF for Year 1 is $37,700.