Table 11.3
Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset will be depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.
-The annual incremental after-tax cash flow from operations for year 1 is ________. (See Table 11.3)

Question

Quizplus · Accepted Answer

The relevant cash flows for year 1 are:

Incremental before-tax net profit = $15,000
Tax at 40% = $6,000
Incremental after-tax net profit = $9,000

Depreciation:
Year 1: ($50,000 + $3,000) x 20% = $10,600

Proceeds from sale of existing equipment:
Sale price = $10,000
Tax on gain = ($10,000 - $12,500) x 40% = -$1,000 (tax benefit)
Net proceeds = $11,000

Total cash inflow for year 1:
Incremental after-tax net profit + depreciation + net proceeds from sale of existing equipment = $9,000 + $10,600 + $11,000 = $30,600

Therefore, the annual incremental after-tax cash flow from operations for year 1 is $16,600 (choice B).

Table 11.3 Cuda Marine Engines, Inc. Must Develop the Relevant Cash Flows