Cape Cod Cranberry Products is evaluating the introduction of a new line of juice drinks consisting of cranberry juice

Cape Cod Cranberry Products is evaluating the introduction of a new line of juice drinks consisting of cranberry juice blended with sweeter juices such as apple or grape. In the first year the product line is introduced, sales are forecasted at $2,000,000, Cost of Goods Sold at $1,200,000, other cash expenses at $300,000, depreciation expense at $800,000. The company has many other profitable product lines. It's marginal tax rate is 35%. Compute operating cash flow for the first year.

Answer: 

Sales                                                                                         $2,000,000

Cost of Goods Sold                                               (1,200,000)

Gross Profit                                                                                $800,000

Other Cash Exp.                                                                                (300,000)

Depreciation                                                                       (800,000)

Net Operating Income                                     (300,000)

Taxes 35%                                                                                           (105,000)

NOPAT (loss)                                                                     (195,000)

Depreciation                                                                       (800,000)

Operating Cash Flow                                       $605,000

LaVigne Wineries is purchasing a new wine press. The equipment will cost $250,000. Transportation and installation will cost another $35,000. Because of increased production, inventories will increase by $15,000. The press will be depreciated using the straight line method to a book value of $0.00 over its useful life of 7 years. Compute depreciation for each year of the project.

Answer:  For depreciation purposes, the cost of the asset includes transportation, but not, of course, working capital investments. ($250,000 + $35,000)/7 = $40,714.29 depreciation expense per year.

Marguerite's Florist is considering the purchase of a new delivery van. It will cost $25,000 plus another $3,000 to have it painted in the company's characteristic floral motif. The van will be depreciated over 5 years using MACRS percentages and a half year convention. Compute depreciation for the second year in the life of the van.

Answer:  For depreciation purposes, the cost of the asset includes repainting, so the base is $25,000 + $3,000) = $28,000. The second year rate 32% so depreciation will be $28,000 × .32 = $8,960.

What is the advantage, if any, to using MACRS rather than straight line depreciation?

Answer:  Assuming that a company is profitable and pays taxes, MACRS allows more of the cost of the asset to be written off in the first few years of its life. The faster write-off reduces taxable income in the early years and raises it in the later years. Because of the time value of money, NPV will be higher if taxes can be deferred and cash flow is higher the early years of a project.