1) At Home Corporation is considering a new project that will generate an increm

Question

1) At Home Corporation is considering a new project that will generate an incremental gross revenue of $2,000,000 and will incur an incremental cost of $500,000 per year for four years. The equipment will cost $1,000,000 and will be depreciated straight line over four years. The firm’s tax rate is 40%. At Home’s incremental free cash flow during the second year is?

2) Use this MACRS depreciation schedule:

Year                                  0           1                2      3

Depreciation rate (% )   33.33    44.45       14.81      7.41

An equipment is purchased for $1,000,000 and is used through end of Year 2.At the end of Year 2, the equipment is sold for $100,000.What is the after tax cash flow from the sale of the equipment if the marginal tax rate is 40%?

Explanation / Answer

1.Cash flow =2000000-500000-1000000=500000

After tax cash flow=500000-(500000*40/100)

=$480000

2)

Book value of asset after year 2 = $1000000 x ( 1 - 0.3333 - 0.4445 - 0.1481) = $1000000 x 0.0741 = $74100.

Given Machine sold for $100000.

Hence, Profit on sale of machine = $100000 - $74100 = 25900

Tax on capital gain = 25900 x 40% = $1036.

Hence, After tax cashflow from sale of the machine = $100000 - $1036 = $98964

After tax cashflow from sale of the machine = $98964

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