Al's Fabrication Shop is purchasing a new rivet machine to replace an existing one. The new machine costs $8,000 and will require an additional cost of $1,000 for modification and training. It will be depreciated using simplified straight line depreciation over five years. The new machine operates much faster than the old machine and with better quality. Consequently, sales are expected to increase by $2,100 per year for the next five years. While it is faster, it is fully automated and will result in increased electricity costs for the firm by $700 per year. It will, however, save about $850 per year in labor costs. The old machine is 20 years old and has already been fully depreciated. If the firm's marginal tax rate is 28%, compute the after tax incremental cash flows for the new machine for years 1 through 5.
A) $2,698
B) $450
C) $2,124
D) $1,620

Question

Quizplus · Accepted Answer

The after-tax incremental cash flows can be calculated by considering the additional revenue, additional costs, and savings, then adjusting for taxes. The calculation is as follows:- Additional revenue: $2,100 per year- Increased costs: $700 per year for electricity- Savings: $850 per year in labor costs- Depreciation: ($8,000 + $1,000) / 5 years = $1,800 per yearThe net benefit before taxes is $2,100 (additional revenue) - $700 (additional costs) + $850 (savings) = $2,250 per year. Depreciation does not affect cash flow directly but provides a tax shield. The tax shield is $1,800 (depreciation) * 28% (tax rate) = $504.The net benefit after taxes is $2,250 - ($2,250 * 28%) = $2,250 - $630 = $1,620. Adding back the tax shield from depreciation gives $1,620 + $504 = $2,124.

Al's Fabrication Shop Is Purchasing a New Rivet Machine to Replace