Your company has spent $500,000 on research to develop a new computer game. The

Question

Your company has spent $500,000 on research to develop a new computer game. The firm is planning to spend $100,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $5,000. The machine has an expected life of 3 years, a $100,000 estimated resale value, and falls under the MACRS 5-Year class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 10 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will be the net cash flow for year one of this project?

Explanation / Answer

Total initial cost = 100,000+5000 = 105,000

under the MACRS 5-Year class life = 20%

Depreciation expense for year 1= 20%*105,000 = 21000

net cash flow for year one of this project = EBIT*(1-tax) + Depreciation  

= (500,000-200,000-21000)*(1-35%)+ 21000=$202,350

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