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. If the firm 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 firm is in the 40 percent marginal tax rate?

Question

Quizplus · Accepted Answer

Free cash flow can be calculated as follows:

Revenue: $12 million
Cash expenses: -$5 million
Depreciation: -$1 million
Taxable income: $6 million ($12 million - $5 million - $1 million)
Taxes at 40%: -$2.4 million ($6 million x 0.4)
Net income: $3.6 million ($6 million - $2.4 million)
Subtract the revenue lost from existing project: -$2 million
Free cash flow: $1.6 million ($3.6 million - $2 million)

Therefore, the free cash flow on the project, per year, if the firm is in the 40% marginal tax rate is $3.4 million (Option B).

A Firm Is Considering Taking a Project That Will Produce