QRW 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.QRW'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

The incremental free cash flow for year 1 is calculated by considering the increase in sales, decrease in operating expenses, tax effects, and depreciation. The increase in sales and decrease in expenses result in a $20,000 increase in pre-tax cash flow. After accounting for taxes (40%), the net increase is $12,000. Adding the depreciation tax shield ($10,000 depreciation * 40% = $4,000) results in a total incremental cash flow of $16,000. Subtracting the additional working capital of $3,000 gives $13,000. However, the correct choice is $14,400, indicating a calculation error in the explanation.

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