The Miners' Deli is considering the purchase of a new computer system for inventory control purposes. It is thought that better inventory management will save the firm $20,000 a year in
Cash expenses although it is not expected to have any effect on revenues. It is also expected
That the deli will be able to reduce its investment in inventory by $5,000 a year. No other net
Working capital accounts are expected to be affected. The system will cost $80,000 and will be
Depreciated using straight-line depreciation over 5 years for tax purposes. The firm pays taxes
At a marginal rate of 25%. What are the annual incremental cash flows for this project?

Question

Quizplus · Accepted Answer

Annual incremental cash flows = Annual cost savings - Depreciation - Taxes on cost savings
Annual cost savings = $20,000 + $5,000 = $25,000
Depreciation = $80,000 / 5 = $16,000
Taxes on cost savings = $20,000 * 0.25 = $5,000
Annual incremental cash flows = $25,000 - $16,000 - $5,000 = $4,000
Therefore, the best choice is B as it is the only option that matches the calculated annual incremental cash flows. - Annual cash savings on expenses = $20,000
- Annual reduction in inventory investment = $5,000
- Annual depreciation expense = $80,000/5 = $16,000
- Tax savings due to depreciation = $16,000 x 25% = $4,000
- Incremental annual cash flow = $20,000 + $5,000 + $4,000 = $29,000
- However, this is before considering the initial cash outflow of $80,000 for the computer system, so subtracting that gives a net annual incremental cash flow of $24,000.

The Miners' Deli Is Considering the Purchase of a New