KADS, Inc., has spent $390,000 on research to develop a new computer game. The f
ID: 2444626 • Letter: K
Question
KADS, Inc., has spent $390,000 on research to develop a new computer game. The firm is planning to spend $190,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $49,000. The machine has an expected life of three years, a $74,000 estimated resale value, and falls under the MACRS 7-year class life. Revenue from the new game is expected to be $590,000 per year, with costs of $240,000 per year. The firm has a tax rate of 40 percent, an opportunity cost of capital of 13 percent, and it expects net working capital to increase by $95,000 at the beginning of the project.
What will the cash flows for this project be? FCF in year 0, 1, 2, 3
KADS, Inc., has spent $390,000 on research to develop a new computer game. The firm is planning to spend $190,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $49,000. The machine has an expected life of three years, a $74,000 estimated resale value, and falls under the MACRS 7-year class life. Revenue from the new game is expected to be $590,000 per year, with costs of $240,000 per year. The firm has a tax rate of 40 percent, an opportunity cost of capital of 13 percent, and it expects net working capital to increase by $95,000 at the beginning of the project.
Explanation / Answer
What will the cash flows for this project be? FCF in year 0, 1, 2, 3
Cash Flow in Year 0 = -Machine cost - Installation cost - Initialinvestment in working capital
Cash Flow in Year 0 = - 190000 - 49000 - 95000
Cash Flow in Year 0 = - 334000
Depreciation in Year 1 = (190000+49000)*14.29% = $ 34,153.10
Depreciation in Year 2 = (190000+49000)*24.49% = $ 58,531.10
Depreciation in Year 3 = (190000+49000)*17.49% = $ 41801.10
Accumulated Depreciation till year 3 = 34153.10 + 58531.10 + 41801.10
Accumulated Depreciation till year 3 = $ 134,485.30
Book value at the end of year 3 = (190000+49000) - 134485.30
Book value at the end of year 3 = $ 104,514.70
Terminal Value = Posttax salvage value + working capital
Terminal Value = 74000 - 40%*(74000-104514.70) + 95000
Terminal Value = $ 181,205.88
Year 1 cash Flow = (Revenue - cost)*(1-tax rate) + Depreciation * tax rate
Year 1 cash Flow = (590000-240000)*(1-40%) + 34153.10*40%
Year 1 cash Flow = $ 223,661.24
Year 2 cash Flow = (Revenue - cost)*(1-tax rate) + Depreciation * tax rate
Year 2 cash Flow = (590000-240000)*(1-40%) + 58531.1*40%
Year 2 cash Flow = $ 233,412.44
Year 3 cash Flow = (Revenue - cost)*(1-tax rate) + Depreciation * tax rate + Terminal Value
Year 3 cash Flow = (590000-240000)*(1-40%) +41801.10*40% + 181205.88
Year 3 cash Flow = $ 407,926.32
Answer
Year 0 Cash Flow = - $ 334,000
Year 1 cash Flow = $ 223,661.24
Year 2 cash Flow = $ 233,412.44
Year 3 cash Flow = $ 407,926.32
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