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 200,000 dollars and that is expected to last for 8 years. MACRS depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 are 43 percent, 30 percent, 19 percent, and 8 percent, respectively. For each year of the project, Fairfax Pizza expects relevant, incremental annual revenue associated with the project to be 296,000 dollars and relevant, incremental annual costs associated with the project to be 258,000 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

Fairfax Pizza All Amounts in $ Year Depreciation Depreciation Rate 1 43% 86000 2 30% 60000 3 19% 38000 4 8% 16000 X is the OCF for Year 1 Y is the OCF for Year 4 Revenue 296000 Revenue 296000 Costs 258000 Costs 258000 Operating Margin 38000 Operating Margin 38000 Depreciation 86000 Depreciation 16000 Net Loss -48000 Net Profit before Taxes 22000 Tax Impact @ 50% 11000 Profit post taxes 11000 Operating Cash Flow Operating Cash Flow Net Loss as above -48000 Profit post taxes 11000 Add : Depreciation 16000 Add : Depreciation 86000 Add : Tax Impact 11000 27000 Operating Cash Flow 38000 Operating Cash Flow 38000 X + Y = $ 38,000 + $ 38,000 = $ 76,000

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