Bedolla Corporation is considering a capital budgeting project that would require investing $160,000 in equipment with an expected life of 4 years and zero salvage value. Annual incremental sales would be $430,000 and annual incremental cash operating expenses would be $310,000. The company's income tax rate is 30% and its after-tax discount rate is 8%. 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 2 is:
A) $80,000
B) $96,000
C) $24,000
D) $120,000

Question

Quizplus · Accepted Answer

To calculate the total cash flow net of income taxes in year 2, we need to calculate the incremental cash inflows and outflows for that year.

Incremental cash inflow in year 2:
= Incremental sales - Incremental cash operating expenses - Depreciation
= $430,000 - $310,000 - ($160,000 / 4)
= $165,000

Incremental cash outflow in year 2:
= Income tax payment
= 0.3 * ($165,000 - $40,000)   // ($165,000 - $40,000) is the taxable income after depreciation
= $37,500

Total cash flow net of income taxes in year 2:
= Incremental cash inflow - Incremental cash outflow
= $165,000 - $37,500
= $127,500

However, we need to subtract the initial investment made in year 0 from this total cash flow to get the cash flow net of income taxes.
Initial Investment = $160,000

Cash flow net of income taxes in year 2:
= $127,500 - $160,000
= -$32,500

Since the cash flow is negative, it means that the project is not generating enough cash inflows to cover the initial investment and income tax payments in year 2. Therefore, the best choice is none of the above.

Bedolla Corporation Is Considering a Capital Budgeting Project That Would