A company is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. If the company takes that project, then it will reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the company is in the 40 percent marginal tax rate?

Question

Quizplus · Accepted Answer

To calculate the free cash flow, we need to deduct the cash expenses and taxes from the revenue and add any depreciation expenses.

So, Free Cash Flow (FCF) = Revenue - Cash Expenses - Taxes + Depreciation

Revenue = $12 million
Cash Expenses = $5 million
Depreciation = $1 million

Taxes = 40% of (Revenue - Cash Expenses - Depreciation - Reduction in cash revenue of existing project)
Taxes = 40% of ($12 million - $5 million - $1 million - $2 million) = $1.6 million

Therefore, FCF = $12 million - $5 million - $1.6 million + $1 million = $6.4 million

Hence, the correct choice is B) $3.4 million.

A Company Is Considering Taking a Project That Will Produce