Question

A company is considering replacing an old equipment with a new, more advanced machine. The new machine costs $100,000, will be used for 5 years, and with a salvage value of $10,000. The old machine has a current book value of $55,000, has 5 years of life remaining, an after-tax salvage value of $55,000 today and $5,000 (after-tax) after 5 years, and an annual depreciation of $10,000. The new machine is expected to increase annual sales by $30,000, and an annual increase in costs of $5,000 (excluding depreciation).   Required rate of return is 10 percent, and tax rate is 40 percent.  

What is the project's operating cash flow in the 3rd year?

Answer 1

Answer :

Project's Operating Cash Flows in the 3rd year :

Operating Cash Flow = [(Incremental Sales - Incremental Cost ) * (1 - Tax rate)] + Tax Shield on incremental Depreciation

Depreciation on New Machine = (Cost of Machine - Salvage Value ) / Number of year of useful Life

= (100000 - 10000) / 5

= 90000 / 5

= 18000

Depreciation on Old Machine = 10000

Incremental Depreciation = Depreciation on New Machine - Depreciation on Old Machine

= 18000 - 10000

= 8000

Operating Cash Flow = [(30000 - 5000 ) * (1 - 0.40)] + (8000 * 0.40)

= [ 25000 * 0.60 ] + 3200

= 15000 + 3200

= 18200