Fairfax Pizza is evaluating a project that would require an initial investment i

Question

Fairfax Pizza is evaluating a project that would require an initial investment in equipment of 600,000 dollars and that is expected to last for 7 years. MACRS depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 are 39 percent, 32 percent, 20 percent, and 9 percent, respectively. For each year of the project, Fairfax Pizza expects relevant, incremental annual revenue associated with the project to be 834,000 dollars and relevant, incremental annual costs associated with the project to be 708,000 dollars. The tax rate is 50 percent. What is (X plus Y) if X is the relevant operating cash flow (OCF) associated with the project expected in year 1 of the project and Y is the relevant OCF associated with the project expected in year 4 of the project?

Explanation / Answer

Initial Investment 600000 Project life 7 years Incremental OCF MACRS rates Depriciation Incremental revenue Incremental costs Incremental profit Tax @ 50% profit - depriciation-Tax Year 1 39 234000 834000 708000 126000 63000 -171000 Year 2 32 192000 834000 708000 126000 63000 -129000 Year 3 20 120000 834000 708000 126000 63000 -57000 Year 4 9 54000 834000 708000 126000 63000 9000 Year 5 834000 708000 126000 63000 63000 Year 6 834000 708000 126000 63000 63000 Year 7 834000 708000 126000 63000 63000 X = is the operating cash flow expected in year 1 = -171000 Y = is the operating cash flow expected in year 4 = +9000 X + Y = -171000 + 9000 = - 162000

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