Question

First American is considering buying a new machine to increase production. It will cost $3,000. Shipping will be $300. It has a three-year class life. At the end of one year they plan to sell the machine for $2,000. The new machine will allow FA to increase revenues by $1,800 each year but expenses will increase by $400 each year. If the new machine is purchased, inventory will decrease by $1,000 and accounts payable will increase by 350. Straight-line depreciation will be used. FA's marginal tax rate is 34% and its cost of capital is 7%.

What is the OCF for year 1?

a)		$1,111
b)		$561
c)		$1,298
d)		$1,950

Answer 1

Sales	$      1,800
Less:
Costs	$         400
Depreciation	$      1,100	=(3000+300)/3
EBT	$         300
Less: Tax payable @ 34%	$         102
Incremental earnings	$          198
Add: Depreciation	$      1,100
Operating cash flow	$      1,298