Corporate Budget
The correct net cash flow for the second year is $455,000
The impact of depreciation -- in all years -- is that it lowers the taxes payable. Depreciation is a non-cash expense, and therefore it lowers the taxable income of the organization. When the taxable income is lowered, the overall taxes are also lower. The depreciation does not count in the net cash flow, and therefore the net cash flow is going to be higher than the net income in any year where there is a depreciation charge.
It should be noted that you must use depreciation for this question. As per GAAP, you have to use depreciation on capital assets. This will create a tax benefit. The tax benefit is an incremental cash flow, and all incremental cash flows are to be included in a net present value calculation. Thus, to exclude the effect of depreciation would be to incorrectly calculate the incremental cash flows.
It is recommended that the company undertake the project.
As a general rule, where there is only one alternative and the decision is a simple yes/no decision, projects with a positive net present value (NPV) should be undertaken. This is because such projects increase the value of the company. This project has a positive net present value of $124,980, and therefore it should be undertaken.
3. By IRR, it is recommended...
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