Monocle Corporation is considering an investment in equipment for $50,000. Data related to the investment is as follows: $$\begin{array}{l}\begin{array} { c c }
&\text { Cash Flow before }\

\text { Year } & \text { Depreciation and Taxes } \
\hline 1 & \$ 25,000 \
2 & 25,000 \
3 & 25,000 \
4 & 25,000
\end{array}
\end{array}$$ Monocle uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 35 percent and the life of the equipment is four years with no salvage value. Cost of capital is 12 percent. What is the annual cash flow for Year 1?

Question

Monocle Corporation is considering an investment in equipment for $50,000. Data related to the investment is as follows: $$\begin{array}{l}\begin{array} { c c } 
&\text { Cash Flow before }\

\text { Year } & \text { Depreciation and Taxes } \
\hline 1 & \$ 25,000 \
2 & 25,000 \
3 & 25,000 \
4 & 25,000
\end{array}
\end{array}$$ Monocle uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 35 percent and the life of the equipment is four years with no salvage value. Cost of capital is 12 percent. What is the annual cash flow for Year 1?

Quizplus · Accepted Answer

To calculate the annual cash flow for Year 1, we first determine the annual depreciation expense, which is the cost of the equipment ($50,000) divided by its useful life (4 years), resulting in $12,500 per year. The cash flow before depreciation and taxes is $25,000. After subtracting the depreciation, the taxable income is $12,500 ($25,000 - $12,500). The tax on this income at 35% is $4,375 ($12,500 * 35%). The after-tax income is thus $8,125 ($12,500 - $4,375). Finally, we add back the depreciation expense (since it's a non-cash charge) to the after-tax income to get the annual cash flow: $8,125 + $12,500 = $20,625.

Monocle Corporation Is Considering an Investment in Equipment for $50,000