Question

Laurel’s lawn care limited has a new mower line that can generate revenues of $120,000 per year. Direct production costs are $40,000, and the fixed costs of maintaining the lawn mower factory are $15,000 a year. The factory originally cost $1 million and is being depreciated for tax purposes over 25 years using straight-line depreciation. Calculate the operating cash flows of the project if the firm’s tax bracket is 25%.

Answer 1

The operating cash flows of the project is $58,750 if the firm’s tax bracket is 25%.

• Depreciation per year = Cost /useful life

                                     = 1,000,000/25

                                     = $40,000

• Income before tax =  Revenue - direct cost - fixed cost -  

                                           depreciation

                                       = 120,000 - 40,000 - 15,000 - 40,000

                                       = $25,000

• Tax expense = 25,000 × 0.25 = $6,250

• Net Income = Income before tax - Tax expense

                            = 25,000 - 6,250

                            = $187,500

• Operating cash flow = net Income + depreciation

                                           = 187,500 + 40,000

                                           = $58,750

• The amount of cash created by a company's regular business operations is measured by operating cash flow (OCF). Operating cash flow shows whether a business can produce enough positive cash flow to support and expand its operations; in the absence of such ability, it may need outside finance for capital investment.

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