Clemson Software is considering a new project whose data are shown below. The re

Question

Clemson Software is considering a new project whose data are shown below. The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year 1 cash flow?
Equipment cost (depreciable basis)
$65,000
Straight-line depreciation rate
33.333%
Sales revenues, each year
$60,000
Operating costs (excl. depr.)
$25,000
Tax rate
35.0%

Explanation / Answer

to find the Cash Flow for each year after Year zero we can find it the following way. Sales - operating cost - deprecation = taxable income taxable income x (1-tax rate) = net income Net income + deprecation = cash flow A note: we add back depreciation in cash because its a NONcash expense. That means it depresses taxable income (thus lowers taxes) but the cash from the deprecation expense DOES NOT come out of the company. Here: Sales = 60000 Depreciation = 65,000/3 = 21667 operating costs = 25000 60000 - 21667 - 25000 = 13333 13333 x (1- 0.35) = 8666.45 8666.45 + 21667 = 30333.45 which is your Cash Flow number. Hope this helps!

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