Your company has spent $180,000 on research to develop a new computer game. The firm is...

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Your company has spent $180,000 on research to develop a newcomputer game. The firm is planning to spend $40,000 on a machineto produce the new game. Shipping and installation costs of $5,000for the machine will be capitalized and depreciated. The machinehas an expected life of five years, a $25,000 estimated resalevalue, and falls under the MACRS five-year class life. Revenue fromthe new game is expected to be $200,000 per year, with costs of$100,000 per year. The firm has a tax rate of 35 percent, anopportunity cost of capital of 14 percent, and it expects networking capital to increase by $50,000 at the beginning of theproject. What will be the operating cash flow (OCF) for year two ofthis project?
MACRS rates:
   Year 1: 20.00%
   Year 2: 32.00%
   Year 3: 19.20%
   Year 4: 11.52%
   Year 5: 11.52%
   Year 6: 5.76%

Answer & Explanation Solved by verified expert

3.7 Ratings (440 Votes)

Time line		0	1	2



Cost of new machine		-45000
Initial working capital		-50000
=Initial Investment outlay		-95000

5 years MACR rate			20.00%	32.00%
Sales			200000	200000
Profits	Sales-variable cost		100000	100000


-Depreciation	=Cost of machine*MACR%		-9000	-14400

=Pretax cash flows			91000	85600
-taxes	=(Pretax cash flows)*(1-tax)		59150	55640
+Depreciation			9000	14400
=after tax operating cash flow			68150	70040


reversal of working capital

+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)
+Tax shield on salvage book value	=Salvage value * tax rate
=Terminal year after tax cash flows

Total Cash flow for the period		-95000	68150	70040

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Transcribed Image Text

Your company has spent $180,000 on research to develop a newcomputer game. The firm is planning to spend $40,000 on a machineto produce the new game. Shipping and installation costs of $5,000for the machine will be capitalized and depreciated. The machinehas an expected life of five years, a $25,000 estimated resalevalue, and falls under the MACRS five-year class life. Revenue fromthe new game is expected to be $200,000 per year, with costs of$100,000 per year. The firm has a tax rate of 35 percent, anopportunity cost of capital of 14 percent, and it expects networking capital to increase by $50,000 at the beginning of theproject. What will be the operating cash flow (OCF) for year two ofthis project?MACRS rates: Year 1: 20.00% Year 2: 32.00% Year 3: 19.20% Year 4: 11.52% Year 5: 11.52% Year 6: 5.76%