Pink Industrial is evaluating a 4-year project that would require an initial investment in equipment of $695,000. The equipment would be depreciated to $107,000 over 7 years using straight-line depreciation. In year 4, the project is expected to have relevant revenue of $336,000 and relevant variable costs of $249,000. In addition, Pink Industrial would have one source of fixed costs associated with the project. Yesterday, Pink Industrial signed a deal with Diamond Marketing to develop an advertising campaign for the project. The terms of the deal require Pink Industrial to pay $56,000 to Diamond Marketing in 4 years. The tax rate is 40 percent. What is the operating cash flow for year 4 that Pink Industrial should use in its NPV analysis of the project?

 

Input instructions: Round your answer to the nearest dollar.

 

To calculate the operating cash flow (OCF) for year 4, we'll follow these steps:

1. **Calculate Depreciation Expense:**  
   The equipment is depreciated from an initial value of $695,000 to $107,000 over 7 years using straight-line depreciation.  
   \[
   \text{Depreciation per year} = \frac{\text{Initial Cost} - \text{Salvage Value}}{\text{Depreciation Period}}
   \]
   \[
   = \frac{695,000 - 107,000}{7} = 84,000
   \]

2. **Calculate Earnings Before Interest and Taxes (EBIT) for Year 4:**  
   - **Revenue for Year 4:** $336,000  
   - **Variable Costs for Year 4:** $249,000  
   - **Depreciation Expense:** $84,000  

   \[
   \text{EBIT} = \text{Revenue} - \text{Variable Costs} - \text{Depreciation}
   \]
   \[
   = 336,000 - 249,000 - 84,000 = 3,000
   \]

3. **Calculate Taxes:**  
   The tax rate is 40%, so:
   \[
   \text{Taxes} = \text{EBIT} \times \text{Tax Rate} = 3,000 \times 0.40 = 1,200
   \]

4. **Calculate Net Income:**  
   \[
   \text{Net Income} = \text{EBIT} - \text{Taxes} = 3,000 - 1,200 = 1,800
   \]

5. **Calculate Operating Cash Flow (OCF) for Year 4:**  
   OCF is given by:
   \[
   \text{OCF} = \text{Net Income} + \text{Depreciation}
   \]
   \[
   = 1,800 + 84,000 = 85,800
   \]

Thus, the operating cash flow for year 4 that Pink Industrial should use in its NPV analysis is **$85,800**.

Would you like more details or have questions on any part of this solution?

Here are some further questions you might consider:
1. How would changing the depreciation method impact the OCF calculation?
2. What would be the effect of a different tax rate on the operating cash flow?
3. How would the OCF change if the project’s revenue or variable costs differed?
4. How does straight-line depreciation differ from other depreciation methods?
5. What role does the fixed cost play in this NPV analysis?

**Tip:** Always separate variable and fixed costs in project evaluations to clarify their impact on net income and cash flow.

Pink Industrial is evaluating a 4-year project that would require an initial investment in equipment of $695,000. The equipment would be depreciated to $107,000 over 7 years using straight-line depreciation. In year 4, the project is expected to have relevant revenue of $336,000 and relevant variable costs of $249,000. In addition, Pink Industrial would have one source of fixed costs associated with the project. Yesterday, Pink Industrial signed a deal with Diamond Marketing to develop an advertising campaign for the project. The terms of the deal require Pink Industrial to pay $56,000 to Diamond Marketing in 4 years. The tax rate is 40 percent. What is the operating cash flow for year 4 that Pink Industrial should use in its NPV analysis of the project?

Learn how to calculate the operating cash flow for Pink Industrial's 4-year project, including depreciation, EBIT, taxes, and net income, with a step-by-step breakdown. This example involves a straight-line depreciation method and a tax rate of 40%. Suitable for students and professionals in business finance and accounting.

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