Question

Incremental Depreciation Schedule Rumpel Felt Co.
	Year 1	Year 2
ΔUCCt-1	$11,000	9.625
dr	0.125	0.25
ΔDepr	1,375	2,406.25
ΔUCCt	9.625	7.218.75

To satisfy the demand for smooth felt, the Rumpel Felt Co. purchased a felt press last year. The machine had an expected life of 3 years at the time of purchase and an estimated salvage value of $200 at the end of the 3 years. The machine was depreciated at 25%. The division manager reports that a new felt press that makes even smoother felt can be purchased for $12,000 (including installation). The new felt press will expand sales from $10,000 to $15,000 a year because the new fashion is for smoother felt. Further, it will reduce labour and raw materials usage sufficiently to cut operating costs from $7,000 to $5,000. (Note that incremental operating costs are negative.) The new machine has an estimated salvage value of $2,000 at the end of 2 years. The new machine requires an increase in felt inventory of $1,000. The old machine’s current market value is $1,000. Taxes are 40%, and the firm’s cost of capital is 10%. What are the incremental cash flows in years 1 and 2 of the replacement project? (Complete the cash flows table provided.)

Rumpel Felt Co. Replacement Project Operating Cash Flows
	Year 1	Year 2
Revenues	$5,000	$5,000
Operating Costs
Depreciation
EBIT
Less: Taxes
NOPAT
Plus: Depreciation
OCF

Answer 1

Solution:-

Rumpel Felt Co. Replacement Project Operating Cash Flows
	Year 1	Year 2
Revenues	$5,000	$5,000
Operating Costs	-$1000	-$1000
Depreciation	$4750	$4750
EBIT	$1250	$1250
Less: Taxes	$500	$500
NOPAT	$750	$750
Plus: Depreciation	$4750	$4750
OCF	$5500	$5500

Incremental operating cost:-Reduce labour and raw material $-2000+increase in inventory$1000 = -$1000

Depreciation on Old Machine:- 1000*25%=$250

Depreciation on New Machine:-$12000-$2000/2 = $5000

So incremental Depreciation:- $4750