Three high school friends founded a company that makes widgets. The trio is expanding and wants to begin manufacturing deluxe widgets. This will require new equipment. You have the following information on this investment project: what are the after-tax cash flows that it is expected to generate?

- Cost of new machinery: $590,000
- Expected life of machinery: 5 years
- Expected salvage value of new machinery after 5 years: $520,000
- Depreciation method: straight line
- Expected sales of deluxe widgets: $140,000 per year
- Cost of raw materials: $70,000 per year
- Cost of additional labor: $20,000 per year
- Additional net working capital required at the start of the project: $20,000
- Tax rate: 35%

Choose the correct after-tax cash flows from the options below:

a. −110 / 27.1 / 27.1 / 27.1 / 27.1 / 78.8
b. −110 / 38.8 / 38.8 / 38.8 / 38.8 / 51.8
c. −103 / 38.8 / 38.8 / 38.8 / 38.8 / 71.8
d. −90 / 27.1 / 27.1 / 27.1 / 27.1 / 78.8
e. −110 / 38.8 / 38.6 / 38.8 / 38.8 / 71.8

To calculate the aftertax cash flows that the investment project is expected to generate, we need to consider several factors. Let's break it down step by step:

Calculate annual depreciation: Since the depreciation method is straight line, we divide the cost of the machinery ($590,000) by the expected life of the machinery (5 years) to get an annual depreciation expense of $118,000.

Calculate annual net profit: Subtract the annual cost of raw material ($570,000) and the cost of additional labor ($20,000) from the expected sales of deluxe widgets ($140,000) to get an annual net profit of $140,000 - $570,000 - $20,000 = -$450,000.

Calculate annual tax: Multiply the annual net profit by the tax rate (35.5%) to get an annual tax of -$450,000 * 35.5% = -$159,750.

Calculate annual aftertax cash flow: Subtract the annual tax from the annual net profit to get the aftertax cash flow: -$450,000 - (-$159,750) = -$290,250.

Calculate salvage value: The salvage value of the machinery after 5 years is given as $520,000.

Calculate the total aftertax cash flow: In the final year, add the annual aftertax cash flow ($290,250) to the salvage value ($520,000) to get the total aftertax cash flow: $290,250 + $520,000 = $810,250.

The aftertax cash flows expected to be generated by the investment project are -$290,250 per year for the first 4 years, and $810,250 in the final year.

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