Question

Company X is purchasing a $12 million machine. It will cost $1 million to transport and install the machine. The machine has a depreciable life of 3 years, it will be fully depreciated using straight-line depreciation, and will have no salvage value. The machine will generate incremental revenues of $5.00 million per year along with incremental costs of $4 million per year. Company X’s tax rate is 20%. What is the incremental free cash flows for Company X at time 0?

I have the answer but how do you work this

Company X is purchasing a $15 million machine. It will cost $1 million to transport and install the machine. The machine has a depreciable life of 3 years, it will be fully depreciated using straight-line depreciation, and will have no salvage value. The machine will generate incremental revenues of $5 million per year along with incremental costs of $4 million per year. Company X’s tax rate is 20%. What is the incremental free cash flows for Company X at time 1?

Answer 1

Option I - incremental free cash flow

At t0 = purchase price + transport and install exp

= $ 12 + $ 1

= - $ 13

Option II - Incremental free cash flow

depriciation = ($ 15+ $ 1) / 3 = 5.333 million

( amount in $ million)   

year	Cash flow	Depreciation	net of dep	tax @ 20%	net	incremental free cash flow ( net + dep)
	1	2	3 = 1-2		4	5 = 4+2
0	-16				-16	-16
1	( 5-4) = 1	5.333	-4.333	0	-4.333	1
2	1	5.333	-4.333	0	-4.333	1
3	1	5.333	-4.333	0	-4.333	1

incremental free cash flow at  t1 = $ 1 million

these are the incremental free cash flow at t1 = $ 1 million and at t0 = - $ 13 million.