The president of Lowell Inc. has asked you to evaluate the proposed acquisition

Question

The president of Lowell Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer’s price is $60,000 and it falls into the MACRS 3-year class (33% in year 1, 45% in year 2, 15% in year 3, and 7% in year 4). Purchase of the computer would require an increase in net operating working capital of $2,000. The computer would increase the firm’s before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 4 years and then be sold for $25,000. The firm’s marginal tax rate is 40 percent, and the project’s cost of capital is 14 percent. What is the operating cash flow in Year 2? A) 19,800 B) 10,240 C) 11,687 D) 13,453 E) 16,200

Explanation / Answer

Net income before tax = 20000 -5000=15000

Income after tax = 15000(1-.40) = 9000

Depreciation for year 2 = 60000*.45 = 27000

T ax savings on depreciation = 27000*.40 = 10800

OCF = 9000 + 10800 = 19800

Correct option is "A"

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