Rock Haven has a proposed project that will generate sales of 1,740 units annually at a selling price of $24 each. The fixed costs are $13,900 and the variable costs per unit are $6.75. The project requires $29,200 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $7,300 and the tax rate is 21 percent. What is the operating cash flow?

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BlackTom AI · Accepted Answer

Question restatement: Rock Haven projects sales of 1,740 units/year at $24 each, with fixed costs of $13,900 and variable costs of $6.75 per unit. The project requires $29,200 of fixed assets depreciated straight-line to zero over 4 years. Salvage value of fixed assets is $7,300. Tax rate is 21%. What is the operating cash flow (OCF)?

First, compute the annual numbers needed for OCF:
- Sales revenue = 1,740 × 24 = 41,760.
- Variable costs = 1,740 × 6.75 = 11,745.
- Fixed costs = 13,900.
- Depreciation per year = 29,200 / 4 = 7,300.
- EBIT = Sales − Variable costs − Fixed costs − Depreciation
  = 41,760 − 11,745 − 13,900 − 7,300 = 8,815.
- Taxes = EBIT × 21% = 8,815 × 0.21 = 1,851.15.
- Net income = EBIT − Taxes = 8,815 − 1,851.15 = 6,963.85.
- Operating cash flow (OCF) is Net income plus back the noncash depreciation: OCF = Net income + Depreciation = 6,963.85 + 7,300 = 14,263.85 ≈ 14,264.

Now, evaluate each answer choice:
- Option "$6,749": This value is far below the computed OCF. It might result from mis-subtracting depreciation twice or applying tax to an incorrect base. Specifically, it ignores the depreciation tax shield correctly or miscomputes EBIT/taxes. The number does not align with the standard OCF formula.
- Option "$9,366": This figure is closer to after-tax earnings but still short of the correct OCF. It could come from using EBIT without subtracting depreciation, or from applying taxes to a smaller base than EBIT. It misses the tax shield provided by depreciation.
- Option "$16,093": This option overestimates OCF. It suggests a miscalculation, perhaps using a higher tax rate on a larger earnings base or adding depreciation to a pre-tax figure without correct tax treatment. It does not reflect the precise interplay of EBIT, taxes, and depreciation.
- Option "$21,349": This is substantially higher and indicates an incorrect approach, such as double-counting some cash flows or applying taxes to an amount that ignores depreciation’s full tax shield. It does not correspond to the standard OCF computation for this setup.
- Option "$14,264": This matches the correct calculation via the standard OCF formula: OCF = (Sales − Variable − Fixed − Depreciation) × (1 − Tax) + (Tax × Depreciation) or, equivalently, Net income + Depreciation, with Net income derived from EBIT minus taxes. Specifically, EBIT = 8,815, Taxes = 1,851.15, Net income = 6,963.85, and OCF = 6,963.85 + 7,300 = 14,263.85 ≈ 14,264.

Conceptual notes on common pitfalls:
- Some incorrect options arise from forgetting to add back depreciation (noncash charge) when forming OCF, leading to too low values.
- Other mistakes stem from misapplying taxes, such as taxing depreciation or using an incorrect EBIT base, which inflates or deflates the result.
- Salvage value is not included in the annual OCF calculation unless specifically asked for the terminal year’s cash flow; for a year-by-year OCF figure, salvage is not part of the recurring operating cash flow.

Summary:
- The correct annual operating cash flow, derived from EBIT, taxes, and the depreciation tax shield, is approximately 14,264. The remaining options reflect common misapplications of the formula or arithmetic errors.

BUSFIN 3220 AU2025 (2110) Exam 3 - Requires Respondus LockDown Browser

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