Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips.It will cost $6 million to buy the machine and $10,000 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 million 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 six years and will be depreciated over those six years.The marginal tax rate is 40%.What are the incremental free cash flows associated with the new machine in year 2?

Question

Quizplus · Accepted Answer

The incremental free cash flow in year 2 is calculated as follows:  1. Calculate the annual depreciation: Total cost = $6,000,000 + $10,000 + $3,000,000 = $9,010,000. Depreciation per year = $9,010,000 / 6 = $1,501,667.  2. Calculate the operating income before tax: Gross profit = $4,000,000, Costs = $1,000,000, Depreciation = $1,501,667. Operating income = $4,000,000 - $1,000,000 - $1,501,667 = $1,498,333.  3. Calculate the tax: Tax = 40% of $1,498,333 = $599,333.  4. Calculate the net income: Net income = $1,498,333 - $599,333 = $899,000.  5. Add back depreciation (a non-cash charge): Cash flow = $899,000 + $1,501,667 = $2,400,667.  Therefore, the incremental free cash flow in year 2 is $2,400,667.

Cameron Industries Is Purchasing a New Chemical Vapor Depositor in Order