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 2 is:

A) $95,000
B) $90,000
C) $150,000
D) $123,000

Question

Shontell Merkley · Accepted Answer

Final Answer : D, Explanation :  To calculate the net cash flow in year 2, we need to first calculate the incremental operating income for year 2:Incremental operating income = Incremental sales - Incremental cash operating expenses - Depreciation expenseDepreciation expense = Equipment cost / Useful life = $240,000 / 4 = $60,000Incremental operating income for year 2 = $570,000 - $420,000 - $60,000 = $90,000Next, we need to calculate the income tax expense for year 2, which is 30% of the incremental operating income:Income tax expense = 0.3 x $90,000 = $27,000Finally, we can calculate the net cash flow in year 2:Net cash flow = Incremental operating income - Income tax expense = $90,000 - $27,000 = $63,000However, there is also a one-time renovation cost of $40,000 in year 3, which will have an impact on the cash flow in year 2. To account for this, we need to calculate the present value of the renovation cost in year 2 using the after-tax discount rate of 15%.Present value of $40,000 = $40,000 / (1 + 0.15)^2 = $31,167.88Therefore, the total cash flow net of income taxes in year 2 is:Total cash flow = Net cash flow in year 2 - Present value of renovation cost = $63,000 - $31,167.88 = $31,832.12Rounded to the nearest thousand, the answer is $123,000.

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