PDF Corp.needs to replace an old lathe with a new,more efficient model.The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000.(The old machine is being depreciated on a straight-line basis over a ten-year useful life.)The new lathe costs $100,000.It will cost the company $10,000 to get the new lathe to the factory and get it installed.The old machine will be sold as scrap metal for $2,000.The new machine is also being depreciated on a straight-line basis over ten years.Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year.PDF's marginal tax rate is 40%.Additional working capital of $3,000 is required to maintain the new machine and higher sales level.The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life.What is the incremental free cash flow during year 1 of the project?

Question

Quizplus · Accepted Answer

To calculate the incremental free cash flow during year 1, we need to consider the following:

1. The initial investment: 
Cost of new lathe: $100,000 
Installation cost: $10,000 
Less: Scrap value of old lathe: $2,000 
Net investment: $108,000

2. The change in operating cash flows: 
Increase in sales: $8,000 
Less: Decrease in operating expenses: $12,000 
Change in operating cash flows: $20,000

3. The change in working capital: 
Additional working capital required: $3,000

4. The tax impact: 
Marginal tax rate: 40%

Using the above information, we can calculate the incremental free cash flow during year 1 as follows:

Incremental free cash flow = (Change in operating cash flows + Change in working capital) x (1 - Tax rate) - Net investment 
                            = ($20,000 + $3,000) x (1 - 0.4) - $108,000 
                            = $14,400

Therefore, the correct answer is B.

PDF CorpNeeds to Replace an Old Lathe with a New,more Efficient