Rollans Corporation has provided the following information concerning a capital budgeting 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 2 is:

A) $80,000
B) $24,000
C) $106,000
D) $130,000

Question

Rollans Corporation has provided the following information concerning a capital budgeting 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 2 is:

A) $80,000
B) $24,000
C) $106,000
D) $130,000

Karen Saladin · Accepted Answer

Final Answer : C, Explanation :  To determine the cash flow net of income taxes in year 2, we need to calculate the project's income before taxes (EBT) and then subtract the income taxes to find the after-tax income (ATI) in year 2.Year 2 Depreciation = (Cost - Salvage Value) / Useful Life= ($600,000 - $60,000) / 5= $108,000EBT in year 2 = Gross Profit - Operating Expenses - Depreciation= $320,000 - $60,000 - $108,000= $152,000Income tax expense in year 2 = Tax Rate x EBT= 0.4 x $152,000= $60,800ATI in year 2 = EBT - Income Tax Expense= $152,000 - $60,800= $91,200Adding back depreciation in year 2, we get the cash flow before taxes in year 2:Cash Flow before taxes in year 2 = ATI + Depreciation= $91,200 + $108,000= $199,200Now we need to subtract the income taxes paid in year 2 to get the cash flow net of income taxes:Cash Flow net of income taxes in year 2 = Cash Flow before taxes in year 2 - Income Tax Expense= $199,200 - $60,800= $138,400Therefore, the correct answer is C) $106,000.

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