A company buys tracking software for its warehouse which,along with the computer system and ancillaries to run it,will cost $1.8 million.This purchase will be deducted over five years.It is expected that the software will reduce inventory by $10.5 million at the end of the first year after it is installed,though there will be an annual cost of $120,000 per year to run the system.If the company's marginal tax rate is 40%,how will the purchase of this item change the company's free cash flows in the first year?

Question

Quizplus · Accepted Answer

The correct answer is A. The purchase of the tracking software will increase the company's free cash flows in the first year by $10,020,000. This is calculated as follows:* Increase in inventory: $10.5 million* Annual cost of running the system: $120,000* Depreciation on the software: $1.8 million / 5 = $360,000* Tax savings on depreciation: $360,000 * 40% = $144,000* Free cash flow: $10.5 million - $120,000 - $360,000 + $144,000 = $10,020,000

A Company Buys Tracking Software for Its Warehouse Which,along with the Computer