A. This answer results from depreciating the building over a 5 year period instead of over 10 years.

B. The third year's cash flow would be: Cash flow from operations after tax: ($1,200,000 - $300,000) × .6 = $540,000

Depreciation tax shield:

1

Depreciation on building = $2,000,000 ÷ 10 = $200,000 per year for 10 years

1

Depreciation on equipment = $3,000,000  ÷ 5 = $600,000 per year for 5 years

2

Total depreciation in Year 3 would be $200,000 + $600,000, or $800,000

The depreciation tax shield in Year 3 is $800,000 × .4, or $320,000

Total cash flow for Year 3 is $540,000 cash flow from operations after tax + $320,000 depreciation tax

shield, or $860,000. 

1

For tax purposes, the depreciable base is 100% of an asset's cost, regardless of which depreciation

method is used and regardless of whether salvage value is expected. 

2

Depreciation on land is not included because land is not depreciated.

C. This answer results from depreciating the land along with the building. However, land is never depreciated, either for tax purposes or book purposes.

D. This answer results from multiplying the pre-tax net cash flow by the tax rate, .40, to calculate the after-tax net cash flow. The pre-tax cash flow should be multiplied by 1 - the tax rate to calculate after-tax cash flow.