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Math  /  Algebra

QuestionPractice question Company Y is considering buying a machine for $100,000\$ 100,000. This would result in an increase in EBIT of $25,000/year\$ 25,000 / y e a r. It would cost $5,000\$ 5,000 to install the equipment, $5,000\$ 5,000 to train employee. Expected life is 10 years with no salvage value. Assume straight-line depreciation, tax rate 34%34 \%, required rate of return 12%12 \%. The project requires an increase in inventory of $25,000\$ 25,000 and liquidates at the end of year 10. Calculate OCF A. $16,500\$ 16,500 B. $27,500\$ 27,500 B. $18,500\$ 18,500 D. $29,500\$ 29,500

Studdy Solution

STEP 1

1. The machine costs \$100,000.
2. The installation and training costs are \$5,000 each.
3. The increase in EBIT is \$25,000 per year.
4. The machine has a life of 10 years with no salvage value.
5. Straight-line depreciation is used.
6. The tax rate is 34%.
7. The required rate of return is 12%.
8. The project requires an increase in inventory of \$25,000, which liquidates at the end of year 10.
9. We need to calculate the Operating Cash Flow (OCF).

STEP 2

1. Calculate the total initial investment.
2. Calculate annual depreciation.
3. Calculate taxable income.
4. Calculate taxes.
5. Calculate net income.
6. Calculate Operating Cash Flow (OCF).

STEP 3

Calculate the total initial investment.
The total initial investment includes the cost of the machine, installation, training, and increase in inventory:
Total Investment=$100,000+$5,000+$5,000+$25,000=$135,000 \text{Total Investment} = \$100,000 + \$5,000 + \$5,000 + \$25,000 = \$135,000

STEP 4

Calculate annual depreciation.
Since the machine uses straight-line depreciation over 10 years with no salvage value:
Annual Depreciation=$100,00010=$10,000 \text{Annual Depreciation} = \frac{\$100,000}{10} = \$10,000

STEP 5

Calculate taxable income.
Taxable income is EBIT minus depreciation:
Taxable Income=$25,000−$10,000=$15,000 \text{Taxable Income} = \$25,000 - \$10,000 = \$15,000

STEP 6

Calculate taxes.
Taxes are calculated as 34% of taxable income:
Taxes=0.34×$15,000=$5,100 \text{Taxes} = 0.34 \times \$15,000 = \$5,100

STEP 7

Calculate net income.
Net income is taxable income minus taxes:
Net Income=$15,000−$5,100=$9,900 \text{Net Income} = \$15,000 - \$5,100 = \$9,900

STEP 8

Calculate Operating Cash Flow (OCF).
OCF is net income plus depreciation:
OCF=$9,900+$10,000=$19,900 \text{OCF} = \$9,900 + \$10,000 = \$19,900
The correct answer is not listed among the options provided. The calculated Operating Cash Flow (OCF) is:
$19,900 \boxed{\$19,900}

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