You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in net operating working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent.
-What is the operating cash flow in Year 1?

Question

Quizplus · Accepted Answer

The operating cash flow in Year 1 is calculated as: Savings from operating costs ($20,000) minus taxes on savings (40% of $20,000 = $8,000), plus depreciation tax shield. Depreciation for Year 1 is $20,000 (MACRS 3-year class, 33.33% of $60,000), and the tax shield is $8,000 (40% of $20,000). Thus, OCF = $20,000 - $8,000 + $8,000 = $20,000.

You Have Been Asked by the President of Your Company