Question

KADS, Inc. has spent $410,000 on research to develop a new computer game. The firm is planning to spend $210,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $51,000. The machine has an expected life of three years, a $76,000 estimated resale value, and falls under the MACRS 7-year class life. Revenue from the new game is expected to be $610,000 per year, with costs of $260,000 per year. The firm has a tax rate of 40 percent, an opportunity cost of capital of 11 percent, and it expects net working capital to increase by $105,000 at the beginning of the project.

What will the cash flows for this project be? I solved Year 0 through 2. Need help with year 3. All the information is there.

Year 0 is: ($366,000.00) Year 1 is: $224,918.76 Year 2 is: $235,576.56 Year 3: ?

Answer 1

Book Value after 3 years = Cost of Machine * [1 - Accumulated Depreciation Rates]

= [$210,000 + $51,000] * [1 - (0.1429 + 0.2449 + 0.1749)]

= $261,000 * [1 - 0.5627]

= $114,135.30

After-tax Salvage Value = Salvage Value - [Tax Rate * (Salvage Value - Book Value after 3 years)]

= $76,000 - [0.40 * ($76,000 - $114,135.30]

= $76,000 - [-$15,254.12] = $91,254.12

OCF for year 3 = [(Sales - Costs) * (1 - t)] + [Depreciation * t]

= [($610,000 - $260,000) * (1 - 0.40)] + [{($210,000 + $51,000) * 0.1749} * 0.40]

= $210,000 + $18,259.56 = $228,259.56

Cash Flow for 3rd year = OCF for year 3 + After-tax Salvage Value + Recovery of Investment in NWC

= $228,259.56 + $91,254.12 + $105,000 = $424,513.68