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 3 is:

A) $41,000
B) $61,000
C) $47,000
D) $50,000

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 3 is:

A) $41,000
B) $61,000
C) $47,000
D) $50,000

Zakary Wienberg · Accepted Answer

Final Answer : C, Explanation :  To find the total cash flow net of income taxes in year 3, we first need to calculate the annual cash flows for years 1-3. From the information given in the table, we can calculate:Year 0: Initial Investment = -$260,000 (outflow)Year 1: Earnings Before Taxes = $120,000; Depreciation Expense = $50,000; Taxable Income = $70,000; Taxes = $21,000 (30% of taxable income); Net Income = $99,000; Add back Depreciation Expense = $50,000; Cash Flow = $149,000 (inflow)Year 2: Earnings Before Taxes = $160,000; Depreciation Expense = $50,000; Taxable Income = $110,000; Taxes = $33,000 (30% of taxable income); Net Income = $127,000; Add back Depreciation Expense = $50,000; Cash Flow = $177,000 (inflow)Year 3: Earnings Before Taxes = $185,000; Depreciation Expense = $50,000; Taxable Income = $135,000; Taxes = $40,500 (30% of taxable income); Net Income = $94,500; Add back Depreciation Expense = $50,000; Cash Flow = $144,500 (inflow)To find the total cash flow net of income taxes in year 3, we simply add up the cash flows for year 3 and subtract the income taxes paid in year 3:Total Cash Flow Net of Income Taxes in Year 3 = $144,500 - $40,500 = $104,000However, we need to take into account the fact that the working capital will be released at the end of the project. From the table, we can see that the additional working capital required at the beginning of the project is $20,000, and this will be released at the end of year 3. So we need to subtract this amount from our answer:Total Cash Flow Net of Income Taxes in Year 3 = $104,000 - $20,000 = $84,000Therefore, the correct answer is C) $47,000.

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