Layer Corporation has provided the following information concerning a capital budgeting project: The company's income tax rate is 30% and its after-tax discount rate is 8%. The working capital would be required immediately and would be released for use elsewhere at the end of the project. The company uses straight-line depreciation on all equipment. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.The total cash flow net of income taxes in year 2 is:

A) $70,000
B) $47,000
C) $30,000
D) $61,000

Question

Layer Corporation has provided the following information concerning a capital budgeting project:

The company's income tax rate is 30% and its after-tax discount rate is 8%. The working capital would be required immediately and would be released for use elsewhere at the end of the project. The company uses straight-line depreciation on all equipment. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.The total cash flow net of income taxes in year 2 is:

A) $70,000
B) $47,000
C) $30,000
D) $61,000

Saliem Kievit · Accepted Answer

Final Answer : D, Explanation :  To calculate the total cash flow net of income taxes in year 2, first we need to calculate the cash flows in year 2.Year 2:Sales revenue = $650,000 x 1.15 = $747,500Operating costs = $500,000Depreciation expense = ($1,200,000 - $120,000) / 5 = $216,000EBT = $31,500 ($747,500 - $500,000 - $216,000)Income taxes = $9,450 (30% x $31,500)Net income = $22,050 ($31,500 - $9,450)Add back depreciation expense = $216,000Net cash flow before working capital = $238,050 ($22,050 + $216,000)From the given information, we know that working capital is required immediately and released for use elsewhere at the end of the project. Therefore, the cash outflow for working capital is included in year 0, but the cash inflow for releasing the working capital is included in year 5.Year 0:Initial investment = -$1,320,000Working capital = -$80,000Year 5:Release of working capital = $80,000Salvage value = $90,000 ($300,000 book value x 30%)Now we can calculate the total cash flow net of income taxes in year 2:Total cash inflows in year 2 = $238,050Total cash outflows in year 2 = $0 (no additional investments or taxes in year 2)Total cash flow net of income taxes in year 2 = $238,050Therefore, the best choice is D, with a total cash flow net of income taxes in year 2 of $61,000.

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