Question

Fairfax Pizza is evaluating a project that would require an initial investment in equipment of 500,000 dollars and that is expected to last for 7 years. MACRS depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 are 38 percent, 31 percent, 21 percent, and 10 percent, respectively. For each year of the project, Fairfax Pizza expects relevant, incremental annual revenue associated with the project to be 830,000 dollars and relevant, incremental annual costs associated with the project to be 745,000 dollars. The tax rate is 50 percent. What is (X plus Y) if X is the relevant operating cash flow (OCF) associated with the project expected in year 1 of the project and Y is the relevant OCF associated with the project expected in year 4 of the project?

Answer 1

Tax rate		50%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Year-7	Total
Cost		$           500,000	$          500,000	$           500,000	$           500,000	$           500,000	$           500,000	$     500,000
Dep Rate		38.00%	31.00%	21.00%	10.00%	0.00%	0.00%	0.00%
Depreciation		$           190,000	$          155,000	$           105,000	$             50,000	$                      -	$                      -	$                -	$ 500,000
Calculation of after-tax salvage value
Cost of machine			$          500,000
Depreciation			$          500,000
WDV			$                     -
Sale price			$                     -
Profit/(Loss)			$                     -
Tax			$                     -
Sale price after-tax			$                     -
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Year-7
Annual revenue		$           830,000	$          830,000	$           830,000	$           830,000	$           830,000	$           830,000	$     830,000
Annual cost		$           745,000	$          745,000	$           745,000	$           745,000	$           745,000	$           745,000	$     745,000
Contribution		$             85,000	$            85,000	$             85,000	$             85,000	$             85,000	$             85,000	$       85,000
Less: Depreciation		$           190,000	$          155,000	$           105,000	$             50,000	$                      -	$                      -	$                -
Profit before tax		$         (105,000)	$          (70,000)	$           (20,000)	$             35,000	$             85,000	$             85,000	$       85,000
Tax@50%		$            (52,500)	$           (35,000)	$            (10,000)	$             17,500	$             42,500	$             42,500	$       42,500
Profit After Tax		$           (52,500)	$          (35,000)	$           (10,000)	$             17,500	$             42,500	$             42,500	$       42,500
Add Depreciation		$           190,000	$          155,000	$           105,000	$             50,000	$                      -	$                      -	$                -
Cash Profit after-tax		$           137,500	$          120,000	$             95,000	$             67,500	$             42,500	$             42,500	$       42,500
Calculation of NPV
Year		Capital		Operating cash	Annual Cash flow
0		$          (500,000)			$          (500,000)
1				$           137,500	$           137,500
2				$           120,000	$           120,000
3				$             95,000	$             95,000
4				$             67,500	$             67,500
5				$             42,500	$             42,500
6				$             42,500	$             42,500
7		$                      -		$             42,500	$             42,500