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2 May, 07:43

Clemson Software is considering a new project whose data are shown below. The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year 1 cash flow? Equipment cost (depreciable basis) $65,000Straight-line depreciation rate 33.333%Sales revenues, each year $60,000Operating costs (excl. depreciation) $25,000Tax rate 35.0%a. $28,115b. $28,836c. $29,575d. $30,333e. $31,092

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  1. 2 May, 08:29
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    Option (D) is correct.

    Explanation:

    Here:

    Sales = 60,000

    Depreciation = 65,000 : 3

    = 21,667

    operating costs = 25,000

    Taxable income = Sales - deprecation - operating cost

    = $60,000 - $21,667 - $25,000

    = $13,333

    Net income = Taxable income * (1 - tax rate)

    = $13,333 x (1 - 0.35)

    = $8666.45

    Cash flow = Net income + deprecation

    = $8666.45 + $21,667

    = $30,333.45

    A note: we add back depreciation in cash because its a Non-cash expense. That means it depresses taxable income (thus lowers taxes) but the cash from the deprecation expense DOES NOT come out of the company.
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