Question

Nokela industries purchases a $40.0 M cyclo-converter. The cyclo-conerter will be depreciated by $ 10.0 M per year over four years, starting this year. Suppose Nokela 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

(a.) Earnings in each of the next 4 years will decrese by 10 million without taxes due to depreciation expenses. But Due to depreciation expenses there will be less tax also of 4 million (10 * 40%) which results in net effect of decrease in income by 6 million each year.

(b.) Cash flow for the first year will be outflow of $36 million(i.e pay $40million for the cylco-converter but due to depreciation it results in $4million outflow of taxes) and add $4 million tax saving for depreciation for the next three years.