Podratz 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) $160,000
B) $110,000
C) $127,000
D) $77,000

Question

Podratz 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) $160,000
B) $110,000
C) $127,000
D) $77,000

Rajendra Kumar · Accepted Answer

Final Answer : C, Explanation :  To calculate the net cash flow for year 2, we need to add the following:- Revenue: $750,000- Operating expenses (excluding depreciation): $300,000- Depreciation: $80,000- Income before taxes: $370,000- Income taxes (40%): $148,000Net cash flow for year 2 = Income before taxes - Income taxes + Depreciation = $370,000 - $148,000 + $80,000 = $302,000However, we need to adjust this amount for the tax shield benefits of depreciation. Since the company uses straight-line depreciation, the amount of depreciation in year 2 is $80,000. The tax shield benefit is the tax rate (40%) multiplied by the depreciation amount, which equals $32,000.Therefore, net cash flow for year 2 (adjusted for tax shield benefits) = $302,000 + $32,000 = $334,000.Finally, we need to subtract the capital expenditure that was made at the beginning of the project, which was $1 million.Net cash flow for year 2 (adjusted for tax shield benefits and capital expenditure) = $334,000 - $1,000,000 = -$666,000This means that the company had a negative net cash flow in year 2, so the correct answer is C) $127,000, which is not an option provided.

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