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The Wolf's Den Outdoor Gear is considering replacing the equipment it uses to produce tents
The Wolf's Den Outdoor Gear is considering replacing the equipment it uses to produce tents. The equipment would cost $1.4 million and lower manufacturing costs by an estimated $215,000 a year. The equipment will be depreciated over 8 years using straight-line depreciation to a book value of zero. The required rate of return is 13 percent and the tax rate is 34 percent. The equipment will be used for 8 years and thereafter will be worthless. What is the annual operating cash flow from this proposed project ?
Expert Solution
The annual operating cash flow of this project will be $201,400
The equipment of $1.4 million will be depreciated over 8 years
- Depreciation per year = $1,400,000 / 8 = $175,000
Costs will decrease by $215,000
So, Gross profit will increase by $215,000
Depreciation will increase by $175,000
So, Operating profit will increase by $215,000 - $175,000 = $40,000
Now, tax rate = 34%
So, Net income will increase by $40,000 * (1 - 0.34) = $26,400
Now, Depreciation is a non cash expense
So, Operating Cash flow = $26,400 + $175,000 = $201,400
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