Question

Your company is analyzing the potential purchase of a new set of tractors for over-the-road use with a MACRS depreciable life of 3 years. The new tractors will replace the existing tractors. Depreciation charges will be $27,500 in year 1; $38,000 in year 2; $11,500 in year 3; and $5,700 in year 4. Estimated revenues and expenses are shown in the following table for the new and the old tractors. The company will pay an estimated 34% tax rate. Assume expenses depreciation and interest.

New Tractor Old Tractor

Year Revenue Expenses   Revenue   Expenses

1 $400,000 $320,000   $350,000 $290,000

2 410,000 320,000 350,000 290,000

3 420,000 320,000 350,000 290,000

(A)Compute operating cash flows (best to set up a table) associated with both the new and the old tractors. Don’t forget to include depreciation in year 4.

(B)Determine the incremental (relevant) operating cash flows as a result of the tractors’ replacement (best to set up a table).

(C)From the results in part B, show the time line of incremental operating cash flows.

Answer 1

1-
New Machine
Year	1	2	3	4
revenue	400000	410000	420000	0
expense	320000	320000	320000	0
depreciation	27500	38000	11500	5700
operating profit	80000	90000	100000	-5700
less taxes-34%	27200	30600	34000	-1938
after tax profit	52800	59400	66000	-3762
add depreciation	27500	38000	11500	5700
operating cash flow =after tax profit+depreciation	80300	97400	77500	1938
Old Machine
Year	1	2	3
revenue	350000	350000	350000
expense	290000	290000	290000
depreciation	0	0	0
operating profit	60000	60000	60000
less taxes-34%	20400	20400	20400
after tax profit	39600	39600	39600
add depreciation	0	0	0
operating cash flow =after tax profit+depreciation	39600	39600	39600
2-	Incremental cash flow
Year	1	2	3	4
Operating cash flow new equipment	80300	97400	77500	1938
Operating cash flow old equipment	39600	39600	39600	0
incremental cash flow	40700	57800	37900	1938
3-	Timeline of incremental cash flow
Year	1	2	3	4
Incremental cash flow	40700	57800	37900	1938