A firm plans to build a plant on land it owns. The firm paid $200,000 for the la

Question

A firm plans to build a plant on land it owns. The firm paid $200,000 for the land 30 years ago. Its current market value is $2,000,000. Construction costs, including machinery, will require an initial outlay of $20,000,000. The project will create sales of $12,000,000 per year for years 1-10. No change in other operating costs is expected. The firm uses straight line depreciation over the 10 year life of the project. Salvage value is $1,000,000. The tax rate is 40%. The incremental operating cash flow in year 5 is $________

Explanation / Answer

Annual depreciation = (cost of asset – salvage value)/ life

                                   =( 20,000,000 – 1,000,000)/ 10

                                   = 1,900,000

Incremental operating cash flow = ( Sales – inc operating cost ) x (1-t) + depreciation x tax rate

                                                      = (12,000,000 -0) x (1-0.40) + 1,900,000 x 0.40

                                                      = 7,960,000

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