You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $250,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $50,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,000. The truck will have no effect on revenues, but it is expected to save the firm $80,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the operating cash flow for this project be during year 3?
A) $25,785
B) $70,975
C) $81,333
D) $85,025

Question

Quizplus · Accepted Answer

The operating cash flow (OCF) for year 3 can be calculated using the formula: OCF = (Savings - Depreciation)(1 - Tax Rate) + Depreciation. However, in year 3, we also need to consider the after-tax salvage value and the recovery of net working capital (NWC). The depreciation in each year for a three-year MACRS class asset is 33.33%, 44.45%, and 22.22% of the asset's initial cost, respectively. For a $250,000 asset, the year 3 depreciation is $250,000 * 22.22% = $55,550. The after-tax salvage value is calculated as the salvage value plus the tax shield on the loss from the sale of the asset (if the book value is less than the salvage value, this would be a gain and taxed accordingly, but in this case, it's a loss because the book value is higher due to depreciation being less than the cost). The book value at the end of year 3 is zero because it's fully depreciated under MACRS for the purpose of this calculation. The recovery of NWC is simply adding back the $5,000. The calculation is as follows:OCF for year 3 = (Savings - Depreciation)(1 - Tax Rate) + Depreciation + After-tax salvage value + Recovery of NWC= ($80,000 - $55,550)(1 - 0.21) + $55,550 + ($50,000 - $50,000 * 0.21) + $5,000= $19,305.5 + $55,550 + $39,500 + $5,000= $70,975.

You Have Been Asked by the President of Your Company