Your company has spent $200,000 on research to develop a new computer game. The
ID: 2751563 • Letter: Y
Question
Your company has spent $200,000 on research to develop a new computer game. The firm is planning to spend $40,000 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 five years, a $25,000 estimated resale value, and falls under the MACRS five-year class life. Revenue from the new game is expected to be $300,000 per year, with costs of $100,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 14 percent, and it expects net working capital to increase by $50,000 at the beginning of the project. What will be the operating cash flow for year one of this project?
Explanation / Answer
Total capital cost = cost of machine + installation cost
= 40,000 +5000
=45000
First year depreciation = total capital cost x MACRS rate
= 45,000 x 20%
= 9,000
Depreciation tax shield = Depreciation x tax rate
= 9000 x 35%
= 3,150
Revenue
300000
(-) cost
-100000
Operating income (without depreciation)
200000
(-) Tax 35%
-70000
Net operating income
130000
(+) Depreciation tax shield
3150
Cash flow for year 1
133150
Revenue
300000
(-) cost
-100000
Operating income (without depreciation)
200000
(-) Tax 35%
-70000
Net operating income
130000
(+) Depreciation tax shield
3150
Cash flow for year 1
133150
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