A company is considering the purchase of some equipment that in the second year of operation should cause an increase in sales of $150,000, an increase in cash expenses of $90,000, and a depreciation deduction of $45,000.If the appropriate tax rate is 20%, the after-tax effect of this equipment on cash flows in year two is _____.

Question

Quizplus · Accepted Answer

The after-tax effect on cash flows is calculated by taking the increase in sales ($150,000), subtracting the increase in cash expenses ($90,000), and then adjusting for the tax effect. The depreciation does not affect cash flow directly but does reduce taxable income. Thus, taxable income is increased by $60,000 ($150,000 - $90,000). The tax on this income is $12,000 ($60,000 * 20%). The net after-tax cash inflow is therefore $48,000 ($60,000 - $12,000). However, considering the depreciation deduction saves $9,000 in taxes ($45,000 * 20%), the total effect is an inflow of $57,000 ($48,000 + $9,000).

A Company Is Considering the Purchase of Some Equipment That