The Wet Corp. has an investment project that will reduce expenses by $25,000 per year for 3 years. The project's cost is $55,000. If the asset is part of the 3-year MACRS category (33% first year depreciation) and the company's tax rate is 34%, what is the cash flow from the project in year 1?

Question

Quizplus · Accepted Answer

First, we need to calculate the MACRS depreciation for year 1. Since the asset belongs to the 3-year MACRS category, the depreciation percentages are: 33%, 45%, 15%, and 7% for years 1 to 4, respectively. In year 1, the depreciation expense will be:
$55,000 x 33% = $18,150

The tax savings from the depreciation expense will be:
$18,150 x 0.34 = $6,171

Therefore, the cash flow from the project in year 1 is:
$25,000 + $6,171 = $22,671

So, the best choice is C, with the explanation that we need to calculate the MACRS depreciation for year 1 and use it to calculate the tax savings, which can be added to the expense reduction to obtain the cash flow from the project in year 1.