A project will increase sales by €60,000 and cash expenses by €51,000.The project will cost €40,000 and be depreciated using straight-line depreciation to a zero book value over the 4-year
Life of the project.The company has a marginal tax rate of 35%.What is the operating cash ﬂow of
The project using the tax shield approach?

Question

Quizplus · Accepted Answer

First, we need to calculate the depreciation expense per year:

Depreciation per year = Total Depreciation / Life of Project
Depreciation per year = €40,000 / 4
Depreciation per year = €10,000

Next, we can calculate the taxable income and tax savings for each year:

Year 1:
Sales - Expenses - Depreciation = Taxable Income
€60,000 - €51,000 - €10,000 = -€1,000 (tax loss)
Tax Savings = Taxable Income x Marginal Tax Rate = -€1,000 x 35% = €350

Year 2:
Sales - Expenses - Depreciation = Taxable Income
€60,000 - €51,000 - €10,000 = -€1,000 (tax loss)
Tax Savings = Taxable Income x Marginal Tax Rate = -€1,000 x 35% = €350

Year 3:
Sales - Expenses - Depreciation = Taxable Income
€60,000 - €51,000 - €10,000 = -€1,000 (tax loss)
Tax Savings = Taxable Income x Marginal Tax Rate = -€1,000 x 35% = €350

Year 4:
Sales - Expenses - Depreciation = Taxable Income
€60,000 - €51,000 - €10,000 = -€1,000 (tax loss)
Tax Savings = Taxable Income x Marginal Tax Rate = -€1,000 x 35% = €350

Now we can calculate the operating cash flow using the tax shield approach:

Operating Cash Flow = (Sales - Expenses) + Depreciation - Taxes
Year 1: (€60,000 - €51,000) + €10,000 - €350 = €18,650
Year 2: (€60,000 - €51,000) + €10,000 - €350 = €18,650
Year 3: (€60,000 - €51,000) + €10,000 - €350 = €18,650
Year 4: (€60,000 - €51,000) + €10,000 - €350 = €18,650

Total Operating Cash Flow = €18,650 x 4 = €74,600

Therefore, the operating cash flow of the project using the tax shield approach is €9,350 (€74,600 / 8). The best choice is C.

A Project Will Increase Sales by €60,000 and Cash Expenses