A firm is evaluating a new machine to replace one of its existing, older machines. If the old machine is replaced, the change in the annual depreciation expense will be $3,000. The firm's marginal tax rate is 30 percent. Which of the following statements is correct?
A)The depreciation expense does not affect the calculation of the supplemental operating cash flows, so it should not be considered in the analysis of the machine.
B)The depreciation expense can be added to the machine's after-tax net operating income to determine its supplemental operating cash flows.
C)The depreciation expense should be added to the machine's initial investment outlay.
D)The depreciation expense is included in the computation of the machine's terminal cash flows.
E)The depreciation expense should be included in the analysis only if it exceeds the tax expense associated with the machine.

Question

Quizplus · Accepted Answer

The depreciation expense can be added to the machine's after-tax net operating income to determine its supplemental operating cash flows. This is because depreciation is a tax-deductible expense and reduces the firm's taxable income, resulting in a lower tax payment. Therefore, the firm will have more cash available for investment. Adding back the depreciation expense to the net operating income reflects the cash inflow generated by the tax savings.

A Firm Is Evaluating a New Machine to Replace One