Athabasca Ag is purchasing 1,000 grain bins at a cost of $40,000 each.Each bin also has a $5,000 delivery and installation cost,and the bins have a capital cost allowance (CCA)rate of 25%.The bins are expected to increase gross profit by $12 million per year,starting at the end of the first year,with annual associated costs of $1.5 million per year.Athabasca has a marginal tax rate of 30%.What are the incremental free cash flows associated with the new bins in year 1?

Question

Quizplus · Accepted Answer

- Each bin costs $40,000 + $5,000 = $45,000.
- The total cost of 1,000 bins is $45,000 x 1,000 = $45 million.
- The CCA rate of 25% means that Athabasca can claim a tax deduction of $11,250 per bin ($45,000 x 25%). The total CCA deduction for 1,000 bins is $11,250 x 1,000 = $11.25 million.
- The net cost of the bins for tax purposes is $45 million - $11.25 million = $33.75 million.
- The gross profit increase per year is $12 million, but there are associated costs of $1.5 million, so the net profit increase is $10.5 million per year.
- The incremental free cash flow in year 1 is calculated as follows:
    - Cash outflow: $45 million for bins + $1.5 million for associated costs = $46.5 million
    - Cash inflow: CCA tax deduction of $11.25 million and net profit increase of $10.5 million, both of which are taxable at the marginal tax rate of 30%
    - Tax on CCA deduction: $11.25 million x 30% = $3.375 million
    - Tax on net profit increase: $10.5 million x 30% = $3.15 million
    - Net cash inflow: $11.25 million - $3.375 million + $10.5 million - $3.15 million = $15.225 million
    - Incremental free cash flow: $15.225 million - $46.5 million = -$31.275 million
- Therefore, the answer is D) -$43.3 million (rounded to the nearest tenth).

Athabasca Ag Is Purchasing 1,000 Grain Bins at a Cost