Correll Corporation is considering a capital budgeting project that would require investing $240,000 in equipment with an expected life of 4 years and zero salvage value. Annual incremental sales would be $570,000 and annual incremental cash operating expenses would be $420,000. The project would also require a one-time renovation cost of $40,000 in year 3. The company's income tax rate is 30% and its after-tax discount rate is 15%. The company uses straight-line depreciation. 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) $83,000
B) $123,000
C) $95,000
D) $110,000

Question

Quizplus · Accepted Answer

First, we need to calculate the annual incremental net cash flows for years 1-4:

Year 1:
Incremental Sales = $570,000
Incremental Operating Expenses = $420,000
Net Cash Flow = $150,000 (570,000 - 420,000)

Year 2:
Incremental Sales = $570,000
Incremental Operating Expenses = $420,000
Depreciation = $60,000 ($240,000 / 4 years)
Taxable Income = $60,000
Income Tax = $18,000 (30% of $60,000)
Net Cash Flow = $162,000 (570,000 - 420,000 - 18,000 + 60,000)

Year 3:
Incremental Sales = $570,000
Incremental Operating Expenses = $420,000
Depreciation = $60,000
Renovation Cost = ($40,000)
Taxable Income = $190,000 ($150,000 + 60,000 - 40,000)
Income Tax = $57,000 (30% of $190,000)
Net Cash Flow = $163,000 (570,000 - 420,000 - 57,000 - 40,000 + 60,000)

Year 4:
Incremental Sales = $570,000
Incremental Operating Expenses = $420,000
Depreciation = $60,000
Taxable Income = $150,000
Income Tax = $45,000 (30% of $150,000)
Net Cash Flow = $165,000 (570,000 - 420,000 - 45,000 + 60,000)

Now, we can calculate the total cash flow net of income taxes in year 3:

Total Cash Flow in Year 3 = $163,000

Therefore, the best choice is C, $95,000.

Correll Corporation Is Considering a Capital Budgeting Project That Would