Question

The Freeman Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 40 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project.
Year 0 Year 1 Year 2 Year 3 Year 4
Investment $37,000
Sales revenue $19,000 $19,500 $20,000 $17,000
Operating costs 4,000 4,100 4,200 3,400
Depreciation 9,250 9,250 9,250 9,250
Net working capital spending 430 480 530 430 ?

Required:
a. Compute the incremental net income of the investment for each year.
b. Compute the incremental cash flows of the investment for each year.

Answer 1

Answer:

a.

Year 0 = $0

Year 1 = $5,750

Year 2 = $6,150

Year 3 = $6,550

Year 4 = $4,350

b.

Year 0 = ($37,000)

Year 1 =  $14,570

Year 2 = $14,920

Year 3 = $15,270

Year 4 = $15,040

Explanation:

a. Computation of  the incremental net income of the investment for each year.

                                       Year 0     Year 1       Year 2     Year 3        Year 4  

Sales revenue                              $19,000    $19,500    $20,000   $17,000

Less Operating costs                    $4,000      $4,100       $4,200    $3,400

Less Depreciation                          $9,250     $9,250      $9,250    $9,250

Net Income                      $0          $5,750      $6,150      $6,550     $4,350

b. Computation of  the incremental cash flows of the investment for each year.

                                      Year 0      Year 1        Year 2      Year 3      Year 4

Investment                  ($37,000)

Sales revenue                               $19,000    $19,500     $20,000   $17,000

Operating costs                            ($4,000)     ($4,100)     ($4,200)   ($3,400)

Net working capital                          ($430)       ($480)        ($530)      ($430)

Recovery                                                                                                $1,870

Cash flow                    ($37,000)    $14,570     $14,920     $15,270    $15,040