Podratz Corporation has provided the following information concerning a capital budgeting project: The company uses straight-line depreciation on all equipment. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.The total cash flow net of income taxes in year 3 is:

A) $61,500
B) $127,000
C) $85,000
D) $100,000

To calculate the total cash flow net of income taxes in year 3, we need to calculate the operating cash flow, taxes paid or saved, and the salvage value.

Year 3 operating cash flow:
$178,000 + $5,000 - $65,000 - $26,000 - $7,000 - $20,000 = $65,000

Taxes paid or saved:
($178,000 - $65,000) * 0.35 = $44,150 tax savings

Salvage value:
$30,000 pre-tax salvage value * (1 - 0.35) = $19,500 after-tax salvage value

Total cash flow net of income taxes in Year 3:
$65,000 + $44,150 + $19,500 = $128,650

However, we need to subtract the depreciation tax shield (which is the tax savings resulting from the depreciation expense) to calculate the final answer:

Depreciation tax shield:
$125,000/5 = $25,000 annual depreciation
$25,000 * 0.35 = $8,750 tax savings due to depreciation
$128,650 - $8,750 = $119,900

Therefore, the total cash flow net of income taxes in year 3 is $85,000 (Option C).