Question

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10 000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4 million per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those six years. The marginal tax rate is 30%. What are the incremental free cash flows associated with the new machine in year 2?

a. $1 298 917.

b. $3 247 834.

c. $2 400 500.

d. $1 001 667.

Answer 1

Cost of Machine = Purchase price of Machine + delivery Cost

= $6,000,000 + $10,000

= $6,010,000

Useful life = 6 years

Depreciation expense = Cost of Machine / Useful life

= $6,010,000 / 6 years

= $1,001,667.67

Calculation of Free Cash Flow of the Machine for Year 2
Particulars	Year 2
Raise in Gross Profits (A)	$4,000,000
Associated Costs (B)	$1,000,000
Depreciation (C )	$1,001,666.67
Profit Before Tax (D = A-B-C)	$1,998,333
Tax @30% (E = D*30%)	$599,500
Profit After Tax (F = D-E)	$1,398,833
Add back Depreciation (F = B)	$1,001,666.67
Free Cash Flow (G = E+F)	$2,400,500
Therefore, Free Cash Flow of the Machine for Year 2 is $2,400,500

Option C is correct