A firm 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. The project would also reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax rate?

Question

Quizplus · Accepted Answer

Free Cash Flow (FCF) is calculated by subtracting cash expenses (CE), taxes (T), and capital expenditures (CAPEX) from revenue (R).

FCF = R - CE - T - CAPEX

Given: 
- Revenue (R) = $12 million 
- Cash Expenses (CE) = $5 million 
- Depreciation expenses = $1 million per year 
- Cash revenues of an existing project is reduced by $2 million
- Marginal tax rate = 40%

Calculation: 
- Taxes (T) = (R - CE - D) * 0.4 
          = ($12 - $5 - $1 - $2) * 0.4 
          = $1.6 million

- CAPEX = $0 (not given in the question)

- FCF = R - CE - T - CAPEX 
        = $12 - $5 - $1.6 - $0 
        = $5.4 million

Therefore, the free cash flow on the project is $5.4 million per year. Option B is the correct answer.

A Firm Is Considering Taking a Project That Will Produce