KADS, Inc., has spent $470,000 on research to develop a new computer game. The f
ID: 2712666 • Letter: K
Question
KADS, Inc., has spent $470,000 on research to develop a new computer game. The firm is planning to spend $270,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $57,000. The machine has an expected life of three years, a $82,000 estimated resale value, and falls under the MACRS 7-year class life. Revenue from the new game is expected to be $670,000 per year, with costs of $320,000 per year. The firm has a tax rate of 40 percent, an opportunity cost of capital of 11 percent, and it expects net working capital to increase by $135,000 at the beginning of the project.
What will the cash flows for this project be? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)
I need to calculate the FCF for years 0, 1, 2, and 3.
Explanation / Answer
Answer: Research and development cost = $470,000 Machine cost = $270,000 Shipping and installation cost = $57,000 Total cost of machine = $270000 + $57000 = $327,000 Machine's expected life = 3 years Resale or salvage value of the machine = $87,000 Depreciation on the macinery is calculated under 7 years MACRS Therefore depreciation is calculated as: Year Rate Depreciation 1 14.29% $46,728.30 2 24.49% $80,082.30 3 17.49% $57,192.30 4 12.49% $40,842.30 5 8.93% $29,201.10 6 8.92% $29,168.40 7 8.93% $29,201.10 8 4.46% $14,584.20 Also working capital changes = increase in working capital = $135,000 tax rate = 40% cost of capital = 11% Revenues= $670,000 Costs = $320,000 Year 0 1 2 3 4 5 6 7 8 Revenue $670,000 $670,000 $670,000 $670,000 $670,000 $670,000 $670,000 $670,000 Costs $320,000 $320,000 $320,000 $320,000 $320,000 $320,000 $320,000 $320,000 Earnings before dep and taxes $350,000 $350,000 $350,000 $350,000 $350,000 $350,000 $350,000 $350,000 Depreciation $46,728.30 $80,082.30 $57,192.30 $40,842.30 $29,201.10 $29,168.40 $29,201.10 $14,584.20 Earning After Tax $303,271.70 $269,917.70 $292,807.70 $309,157.70 $320,798.90 $320,831.60 $320,798.90 $335,415.80 Tax (40%) $121,308.68 $107,967.08 $117,123.08 $123,663.08 $128,319.56 $128,332.64 $128,319.56 $134,166.32 Net income $181,963.02 $161,950.62 $175,684.62 $185,494.62 $192,479.34 $192,498.96 $192,479.34 $201,249.48 Increase in working capital $135,000 $135,000 $135,000 $135,000 $135,000 $135,000 $135,000 $135,000 After tax Salvage value $52,200 Net Cash Flows =Net income - increase in working capital + salvage value+dep $93,691.32 $107,032.92 $150,076.92 $91,336.92 $86,680.44 $86,667.36 $86,680.44 $80,833.68 Investment ($797,000) Therefoe NPV of the project at 11% discount rate = ($281,218.91) The project is not acceptable as the NPV is negative
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