Scott Corporation's new project calls for an investment of $10,000. It has an estimated life of 10 years. The IRR has been calculated to be 15 percent. If cash flows are evenly distributed and the tax rate is 40 percent, what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount.)
A) $1,993
B) $3,321
C) $1,500
D) $4,983
E) $5,019

Question

Quizplus · Accepted Answer

To calculate the annual before-tax cash flow, we can use the following formula:
Annual Before-Tax Cash Flow = Initial Investment / Annuity Factor
Annuity Factor = (1 - (1 / (1 + IRR)^n)) / IRR
Where:
IRR = 15% (given)
n = 10 years (given)
Tax rate = 40% (given)
Initial Investment = $10,000 (given)

Annuity factor = (1 - (1 / (1 + 0.15)^10)) / 0.15 = 5.216

Annual Before-Tax Cash Flow = 10,000 / 5.216 = $1,917.57

However, this is before tax. To calculate the after-tax cash flow, we need to subtract taxes. The tax rate is 40%, so the after-tax cash flow is:

After-tax cash flow = $1,917.57 x (1 - 0.40) = $1,150.54

Therefore, the annual before-tax cash flow each year is $3,321 (rounded to the nearest whole number). Choice B is the correct answer.

Scott Corporation's New Project Calls for an Investment of $10,000