Question

Nokela Industries purchases a $ 42.0 million​ cyclo-converter. The​ cyclo-converter will be depreciated by $ 10.5 million per year over four​ years, starting this year. Suppose​ Nokela's tax rate is 25 %. 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

Question a.

Impact on earnings-Depreciation will reduce the earnings by $10.5 million every year however it will also provide with taxation benefit of 25%, hence each year for next 4 years profit will be reduced by $(10.5-25% of 10.5) million=$7.875 million.

Question b.

Impact on cash flow-Depreciation will not entail any cash flow, however there will cash savings of tax savings on depreciation, hence cash outflow will be reduced by 25% of $10.5 million each year for next 4 years=25%* $ 10.5 million=$2.625 million.