Question

Fairfax Pizza is evaluating a project that would require an initial investment in equipment of 400,000 dollars and that is expected to last for 7 years. MACRS depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 are 45 percent, 33 percent, 16 percent, and 6 percent, respectively. For each year of the project, Fairfax Pizza expects relevant, incremental annual revenue associated with the project to be 628,000 dollars and relevant, incremental annual costs associated with the project to be 552,000 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?

Answer 1

$178,000

Explanation:

The calculation of X and Y is shown below:-

Before that we need to do the following calculations

`Depreciation\ in \ 1\ year = 45\%* Initial\ investment`

`= 0.45*\$400,000`

= $180,000

`Depreciation\ in \ 4\ year = 6\%* Initial\ investment`

`= 0.06*\$400,000`

= $24,000

Now, Operating cash flow of X in Year 1

`X = (Revenue - Cost)* (1 - Tax \ rate) + Depreciation* tax \ rate`

`X = (\$628,000 - \$552,000)* (1 - 0.50) + \$180,000* 0.50`

= $38,000 + $90,000

= $128,000

and Operating cash flow of Y in Year 4

`Y = (Revenue - Cost)* (1 - Tax \ rate) + Depreciation* tax \ rate`

`Y = (\$628,000 - \$552,000)* (1 - 0.50) + \$24,000* 0.50`

= $38,000 + $12,000

= $50,000

`X + Y = Operating\ cash\ flow\ for\ the\ year\ 1 + Operating\ cash\ flow\ for\ the\ year\ 2`

= $128,000 + $50,000

= $178,000

hence, the X + Y is $178,000