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 1?

Question

Quizplus · Accepted Answer

The incremental free cash flows in year 1 are calculated as follows:

Gross profit: $4,000,000
Less: Associated costs: $1,000,000
Less: Depreciation (straight-line method): $1,000,000 x (1/6) = $166,667
Less: Taxes (40%): ($4,000,000 - $1,000,000 - $166,667) x 0.4 = $1,013,333
Add: Depreciation: $166,667

Total incremental free cash flow in year 1: -$6,010,000

Therefore, the best choice is A.

Cameron Industries Is Purchasing a New Chemical Vapor Depositor in Order