Question

A company experiencing a 40% marginal tax rate makes an investment of $1,000 in equipment with...

A company experiencing a 40% marginal tax rate makes an investment of $1,000 in equipment with a ten year useful life and generates $150 of incremental EBIT from the investment every year following the investment. It makes no additional investments after this transition.

1. If the investments is made on the last day of the year, what will the impact on Cash Flow from Investing be in that year?

2. If the investments is made on the last day of the year, what will the impact on Free Cash Flow be in that year?

3. What will the impact on Pretax Income be in the following year?

4. What will the impact on Net Income be in the following year?

5. What will the impact on Cash Flow from Operations be in the following year?

6. What will the impact on Free Cash Flow in the following year?

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Answer #1

1. Cashflow from investing will decline by the amount of investment made. Hence Cash flow from investment will decrease by 1,000.

2. Impact on Free Cash flow

=> - 1000 there will be outflow of free cashflows of 1000.

3. Impact on pre tax income in the following year = 150 .

Pre tax income will increase by 150 due to investment made.

4. Net Income will increase by 90 in the following year= 150 *(1-0.4) => 90

5. Impact on Cash flow from Operations in the following year = 90, they will increase by 90 in the follwing year.

6. Free Cash flow will also increase by 90 in the following year.

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