Question

Lily’s Loving Laundry is thinking about installing a new steam press at its facility so it can add in-house pressing services to its product offerings. The new press steamer will cost $14,400. It will last for five years, be depreciated on a straight-line basis to a salvage value of $4000 but will be resold for $1,400 after five years (assume no taxes apply).

Lily estimates its demand to press shirts as: 9000, 9000, 9000, 9200, 9200 in years one through five respectively. A new steam press operator will need to be hired at $13.00 per hour and will work 40 hours per month for the year. That employee will get a raise of $0.25 per year every year starting in the second year. Shirts currently cost customers $3 for dry cleaning; and an additional charge of $1.35 will be added for pressing. Lily will also need to add a $1,500 annual insurance policy to cover any steam-related accidents.

Assume Lily pays 17% in tax on its taxable income and is looking at a five-year return period over which she would expect to earn a 10% rate of return.

What is the amount of Cash Flows Out for Year 3 (rounded to the nearest dollar)?

A) $12,150
B) $8,369
C) $1,880
D) None of the above

Answer 1

Solution: The Answer is D "None of the Above". Refer to the workings below

Step 1: Details of Cash Flow for years 0 to years 5 Year 1 Year 5 Description Year 0 Year 2 Year 3 Year 4 Cash Out Flow (14,400) $ $ $ $ $ New Press Steamer Salary @ 40 hours 12 month $ Annual Insurance Income Tax @ 17% (Step 2 ) (6,360) $ (1,500) $ (6,600) $ (1,500) $ (5,073) $ (13,173) $ (6,240) $ $ (6,480) $ (1,500) $ (4,945) S (12,925) $ (6,720) (1,500) $ (1,500) $ (4,986) $ (12,726) $ $ $ (4,966) $ (5,052) (12,826) $ $ (13,272) Cash In Flow Sales Demand (Nos) Dry Cleaning @ $ 3.00 Pressing @ $ 1.35 9,000 9,000 9,200 9,000 9,200 27,600 $ 12,420 $ $ $ 27,000 $ 27,000 $ 27,000 $ 27,600 $ $ 12,150 $ 12,420 12,150 $ 12,150 $ n

Step 2: Calculation of Income Tax for years 0 to years 5 Year O Year 1 Year 2 Year 4 Description Year 3 Year 5 Cash In flow $ $ 39,150 $ 39,150 $ 40,020 $ 39,150 $ 40,020 Cash out Flow Depreciation (Step 3) Net Cash Flow before Tax $ $ (7,740) $ (2,080) $ $ (7,860) $ (2,080) $ 29,210 $ (7,980) $ (2,080) $ 29,090 $ (8,100) $ (2,080) $ 29,840 $ (8,220) $ (2,080) 29,330 $ $ 29,720 Income Tax @ 17% (4,986) $ (4,966) $ (4,945) $ (5,073) $ (5,052)

Step 3: Calculation of Depreciation for years 0 to years 5 Description Amount New Press Steamer cost Less: Salvage Value Net Press Steamer cost $ 14,400 $ (4,000) $ 10,400 No of Years 5 Years Straight Line Basis Depn $ 2,080