Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6,000,000 to buy the machine and $20,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4,000,000 per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of five years and will be depreciated over those five years. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 0?

Question

Quizplus · Accepted Answer

The incremental free cash flows associated with the new machine in year 0 can be calculated as follows:
Initial investment = -$6,000,000 - $20,000 - $3,000,000 = -$9,020,000
Depreciation = -$6,000,000 / 5 = -$1,200,000 per year
Tax shield on depreciation = $1,200,000 x 0.4 = $480,000 per year
Net investment = initial investment - tax shield on depreciation = -$9,020,000 - $480,000 = -$9,500,000
Therefore, the incremental free cash flow in year 0 is -$9,500,000. The closest answer choice is A, which is -$6,020,000, but this is not correct.

Cameron Industries Is Purchasing a New Chemical Vapor Depositor in Order