For example, look at a project with a depreciation life of 3 years according to the I.R.S. using the half-year convention. The following rates apply
| Year 1 | 33.33% |
| Year 2 | 44.45% |
| Year 3 | 14.81% |
| Year 4 | 7.41% |
The project costs 100,000 and is expected to generate operating income of $50,000 per year.The firm is in a 35% tax bracket and wants to estimate the cash flows:
| Year | 1 |
2 |
3 |
4 |
| Operating Income | $50,000 |
$50,000 |
$50,000 |
$50,000 |
| Less Depreciation | -33,333 |
-44,450 |
-14,810 |
-7,410 |
| Profit Before Tax | 16,667 |
5,550 |
35,190 |
42,590 |
| Less Tax | -5,833 |
-1,943 |
-12,317 |
-14,907 |
| Profit After Tax | 10,834 |
3,607 |
22,873 |
27,683 |
| Plus Depreciation | 33,333 |
44,450 |
14,810 |
7,410 |
| Cash Flow | $44,167 |
$48,057 |
$37,683 |
$35,093 |
An alternative is to multiply the operating income by (1 - tax rate) and add the depreciation multiplied by the tax rate. Since the purpose of depreciation is to save taxes, this captures the tax savings provided by depreciation and is a simpler means to estimate cash flows:
| Year | 1 |
2 |
3 |
4 | ||||
| Operating Income | $50,000 |
$50,000 |
$50,000 |
$50,000 |
||||
| times (1-.35) = | $32,500 |
$32,500 |
$32,500 |
$32,500 |
||||
| Depreciation | 33,333 |
44,450 |
14,810 |
7,410 |
||||
| times .35 = | 11,667 |
15,557 |
5,183 |
2,593 |
||||
| Cash Flow | $44,167 |
$48,057 |
$37,683 |
$35,093 |