Question

Nokela Industries purchases a

$40.4

million​ cyclo-converter. The​ cyclo-converter will be depreciated by

$10.1

million per year over four​ years, starting this year. Suppose​ Nokela's tax rate is

40%.

a. What impact will the cost of the purchase have on earnings for each of the next four​ years?

b. What impact will the cost of the purchase have on the​ firm's cash flow for the next four​ years?

Answer 1

Solution

Part A

Earnings will decline by $6.06 million each year for four years

Earnings for the next four years would have to deduct the depreciation expense. After taxes, this would lead to a decline of 10.1 × (1 – 40%) = $6.06 million each year for the next four years.

Part B

The impact on the firm’s cash flow in years 1 is $(36.36) million (-6.06+10.1-40.4)

The impact of the firms’s cash flow in years two through four is $4.04 million (10.1-6.06)

Cash flow for the next four years: less $36.36 million (-6.06+10.1-40.4) this year, and add $4.04 million
(10.1-6.06) for the three following years