A project has an annual operating cash flow of $45000. Initially, this four-year project required $3800 in net working capital, which is recoverable when the project ends. The firm also spent $21500 on an asset with an useful life of 5 years to start the project. What is the cash flow for Year 4 of the project if the equipment can be sold for $5400 and the tax rate is 30%?

Question

BlackTom AI · Accepted Answer

We start by identifying the cash flow components in Year 4 for this project.

First, the annual operating cash flow (OCF) is given as 45,000. This is a steady stream during the project's life and is included in Year 4 as well.

Next, consider the net working capital (NWC). The project requires 3,800 of NWC upfront, which is recoverable at the end of the project. Therefore, in Year 4, you receive the full 3,800 as a cash inflow when the project ends.

Then, evaluate the equipment disposition. The asset costs 21,500 and has a 5-year life with straight-line depreciation, so annual depreciation is 21,500 / 5 = 4,300. After 4 years, the book value of the asset is 21,500 − (4 × 4,300) = 4,300. If the asset is sold for 5,400, there is a gain of 5,400 − 4,300 = 1,100 on sale. With a tax rate of 30%, taxes on the gain are 0.30 × 1,100 = 330. The after-tax cash inflow from the sale is 5,400 − 330 = 5,070.

Now combine the components for Year 4: 
OCF 45,000 + NWC recovery 3,800 + after-tax salvage 5,070 = 45,000 + 3,800 + 5,070 = 53,870.

Reviewing the other options, small arithmetic differences arise from misaccounting for either the salvage tax effect, the NWC recovery, or the handling of depreciation. For example, neglecting the tax on the salvage or forgetting the NWC recovery would yield values like 52,038, 41,660, 53,900, or 53,862, which are not consistent with all components combined as shown above.

Therefore, the Year 4 cash flow is 53,870.

BFIN011 Week 4: Practice Quiz

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