Silver Shipping is evaluating a 5-year project that would require an initial investment in equipment of $490,000. Accelerated depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 would be 25%, 40%, 20%, and 15%, respectively. In year 2, the project is expected to have relevant revenue of $221,000 and relevant variable costs of $91,000. In addition, Silver Shipping would have one source of fixed costs associated with the project. Yesterday, Silver Shipping signed a deal with Diamond Advertising to develop an advertising campaign for the project. The terms of the deal require Silver Shipping to pay $23,000 to Diamond Advertising in 2 years. The tax rate is 35 percent. What is the operating cash flow for year 2 that Silver Shipping should use in its NPV analysis of the project?

 

Input instructions: Round your answer to the nearest dollar.

 

To determine the operating cash flow (OCF) for Year 2, we need to follow these steps:

1. **Calculate Depreciation Expense for Year 2**:
   - The initial equipment investment is $ 490,000 $.
   - The depreciation rate for Year 2 is $ 40\% $.
   - **Depreciation Expense (Year 2)** = $ 490,000 \times 0.40 = 196,000 $.

2. **Determine Earnings Before Interest and Taxes (EBIT)**:
   - Revenue in Year 2 = $ 221,000 $
   - Variable costs in Year 2 = $ 91,000 $
   - Fixed costs: The fixed cost for the project is not directly given in the problem. However, the advertising campaign fee of $ 23,000 $ is relevant only for calculating OCF but is not included as an operating cost for Year 2.
   
   Without additional information on fixed costs, we’ll assume the **EBIT calculation is based on the given revenue and variable costs only**:
   \[
   \text{EBIT} = \text{Revenue} - \text{Variable Costs} - \text{Depreciation Expense}
   \]
   Plugging in the values:
   \[
   \text{EBIT} = 221,000 - 91,000 - 196,000 = -66,000
   \]

3. **Calculate Tax on EBIT**:
   - Since EBIT is negative, we won't have any tax expenses in Year 2.
   - **Tax** = $ -66,000 \times 0.35 = 0 $ (no tax effect as there’s no taxable income).

4. **Calculate Operating Cash Flow (OCF)**:
   - OCF is calculated using the formula:
     \[
     \text{OCF} = (\text{EBIT} + \text{Depreciation}) \times (1 - \text{Tax Rate})
     \]
     Substituting the values we have:
     \[
     \text{OCF} = (-66,000 + 196,000) = 130,000
     \]
     Hence, the Operating Cash Flow (OCF

Silver Shipping is evaluating a 5-year project that would require an initial investment in equipment of $490,000. Accelerated depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 would be 25%, 40%, 20%, and 15%, respectively. In year 2, the project is expected to have relevant revenue of $221,000 and relevant variable costs of $91,000. In addition, Silver Shipping would have one source of fixed costs associated with the project. Yesterday, Silver Shipping signed a deal with Diamond Advertising to develop an advertising campaign for the project. The terms of the deal require Silver Shipping to pay $23,000 to Diamond Advertising in 2 years. The tax rate is 35 percent. What is the operating cash flow for year 2 that Silver Shipping should use in its NPV analysis of the project?

Learn how to calculate operating cash flow for a project involving depreciation, revenue, and tax considerations. This problem includes a 5-year project with initial investment, accelerated depreciation, tax rate, and advertising campaign costs. A step-by-step solution shows how to compute OCF using EBIT and depreciation values.

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