1. A project will increase sales by $60,000 and cash expenses by $41,000. The pr

Question

1. A project will increase sales by $60,000 and cash expenses by $41,000. The project will cost $40,000 and be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. The company has a marginal tax rate of 35 percent. What is the operating cash flow of the project using the tax shield approach?

a. $12,350

b. $8,650

c. $15,850

d. $13,150

e. $10,350

2. Assume an asset cost $41,500 and has a current book value of $23,200. The asset is sold today for $19,900 cash. The firm's tax rate is 34 percent. As a result of this sale, the firm's net cash flow:

a. will increase by exactly $19,900.

b. will decrease by the difference between the $23,200 and the $19,900.

c. will increase by more than $19,900.

d. will increase by less than $19,900.

e. will decrease by some amount.

Explanation / Answer

Solution 1:

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

                                        = (40,000 -0)/ 4

                                        = 10,000

Depreciation tax shield = 10,000 x 35%

                                                = 3,500

Operating cash flow = (revenue – cash expenses) x (1- tax rate) + depreciation tax shield

                                        = (60,000 -41,000) x( 1- 0.35) + 3500

                                        = 12350+3500

                                       = 15850

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