Question

Delta Inc. is considering the purchase of a new machine which is expected to increase sales by $10,000 in addition to increasing cash expenses by $3,000 annually. Due to the sales increase, Delta will need to increase working capital by $2,000 at the beginning of the project. This working capital investment will not be recouped in the final year of the project. Delta will depreciate the machine using the straight-line method over the project's five-year life to a salvage value of $2,000. The machine's purchase price is $20,000. The firm has a marginal tax rate of 21%. Q). What is the project's incremental after-tax cash flow in year 1?

Answer #1

The project's incremental after-tax cash flow in year 1 = {Expected increase in sales - addition to increasing cash expenses – annual depreciation}*(1-tax rate) + annual depreciation

Where,

Expected increase in sales = $10,000 per year

Addition to increasing cash expenses = $3,000 per year

Annual depreciation= {machine's purchase price –salvage value}/ useful life

= ($20,000 - $2,000)/5 = $3,600

Tax rate = 21%

Therefore,

The project's incremental after-tax cash flow in year 1 = {$10,000 - $3,000 - $3,600} * (1- 21%) + $3,600

= $3,400 *(1- 21%) + $3,600

= $2,686 +$3,688

= $6,286

Therefore the project's incremental after-tax cash flow in year 1 is $6,286.

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