Question

Capital Budgeting-Annual Cash Flow
Loxahatchee Corporation is trying to decide whether to invest to automate a production line. If
the project is accepted, labor costs will fall by $155,000 per year. However, other cash operating
expenses will increase by $85,000 per year. The equipment will cost $240,000 and is depreciable
over 10 years using simplified straight line. Net working capital is $,8,000 and the marginal tax
rate is 34%. Calculate the firm's annual cash flows associated with the new project.

Answer 1

Cost of Equipment = $240,000
Useful Life = 10 years

Annual Depreciation = Cost of Equipment / Useful Life
Annual Depreciation = $240,000 / 10
Annual Depreciation = $24,000

Decrease in Labor Cost = $155,000
Increase in Operating Expenses = $85,000

Pretax Cost Saving = Decrease in Labor Cost - Increase in Operating Expenses
Pretax Cost Saving = $155,000 - $85,000
Pretax Cost Saving = $70,000

Annual Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Cash Flow = $70,000 * (1 - 0.34) + 0.34 * $24,000
Annual Cash Flow = $46,200 + $8,160
Annual Cash Flow = $54,360

So, firm’s annual cash flows associated with the new project is $54,360