Problem 8-17 Calculating Nominal Cash Flovw Price, Inc., is considering an inves

Question

Problem 8-17 Calculating Nominal Cash Flovw Price, Inc., is considering an investment of $377,000 in an asset with an economic life of 5 years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be $257,000 and $82,000, respectively. Both revenues and expenses will grow thereafter at the annual inflation rate of 3 percent. Price will use the straight-line method to depreciate its asset to zero over five years. The salvage value of the asset is estimated to be $57,000 in nominal terms at that time. The one-time net working capital investment of $16,000 is required immediately and will be recovered at the end of the project. All corporate cash flows are subject to a 34 percent tax rate. What is the project's total nominal cash flow from assets for each year? (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.) Cash flow Year O Year 1 Year 2 Year 3 Year 4 Year 5

Explanation / Answer

1. Provides the nominal values at the end of the first year, so to find the values for revenue and expenses at the end of year 5, compound the values by four years of inflation, e.g. $257,000*(1.03)4 = $289,256

2. When calculating the salvage value of the asset only the gain on the sale of the asset is taxed. As book value will be zero at end of five year hence total $ 57,000 will bw gain and net gain after tax will be 57000- (34% of 57000) = 37,620

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 1 Revenue        2,57,000        2,64,710        2,72,651        2,80,831        2,89,256 2 Expences 82,000 84,460 86,994 89,604 92,292 3 Depreciation 75,400 75,400 75,400 75,400    75,400 4 Taxable Income (1-2-3)          -   99,600        1,04,850        1,10,258        1,15,827        1,21,564 5 Tax @ 34% 33,864    35,649    37,488    39,381     41,332 6 Operating Cash Flow (1-2-5)    -          1,41,136        1,44,601        1,48,170        1,51,846        1,55,632 7 Net Working Capital -16,000 16,000 8 Investment        -3,77,000 37,620 9 Total Cash Flow        -3,93,000        1,41,136        1,44,601        1,48,170        1,51,846        2,09,252

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