Question

Etonic Inc. is considering an investment of $365,000 in an asset with an economic life of five years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be $245,000 and $70,000 respectively. Both revenues and expenses will grow thereafter at the annual rate of 3 percent. Etonic will use the straight-line method to depreciate its asset to zero over five years. The salvage value of the asset is estimated to be $45,000 in nominal terms at that time. The one-time net working capital investment of $10,000 is required immediately and will be recovered at the end of the project. All corporate cash flows are subject to a 34 percent tax rate. What is the project’s total cash flow from assets for each year?

Answer 1

Solution:

Annual depreciation = (Cost - Salvage value) / Useful life = ($365,000 - $45,000)/5 = $64,000

Computation of cash flow from assets
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Cash Revenues	$245,000	$252,350	$259,921	$267,718	$275,750
Cash Expenses	$70,000	$72,100	$74,263	$76,491	$78,786
Depreciation	$64,000	$64,000	$64,000	$64,000	$64,000
Income before taxes	$111,000	$116,250	$121,658	$127,227	$132,964
Income tax expense	$37,740	$39,525	$41,364	$43,257	$45,208
Net Income	$73,260	$76,725	$80,294	$83,970	$87,756
Add: Depreciation	$64,000	$64,000	$64,000	$64,000	$64,000
Annual cash inflows	$137,260	$140,725	$144,294	$147,970	$151,756