Question

Six years ago, Nebrow Inc. purchased a polishing machine for $600,000. The company expected to use the machine for 10 years with no residual value at the end of the tenth year. The machine has been generating annual cash revenue of $460,000 and incurring annual cash operating costs of $210,000. Nebrow is considering the purchase of a new digital polishing machine for $800,000, which will have annual cash revenues of $690,000 and annual cash operating costs of $180,000.
The new machine is expected to have a useful life of four years. The company uses the straight-line depreciation method with no salvage value to depreciate all of its assets. Assume, for purposes of analysis, that Nemrow is subject to a combined 40% tax rate.
Required:
What is the annual incremental after-tax cash flow from the new polishing machine? Show the results

Answer 1

Old polishing machine

Cost = 600000

Life = 10 years

Annual cash revenue = 460000

Annual operating cost = 210000

Annual dep = Cost / life of machine = 600000/10 = 60000 (No salvage value)

Annual net income Before tax = Revenue - Cost - dep = 460000-210000-60000 = 190000

Annual net income after tax = 190000 - 40% tax = 190000 - 76000 = 114000

Annual cash flow after tax = Net income after tax + Depreciation = 114000 + 60000 = 174000

new polishing machine

Cost = 800000

Life = 4 years

Annual cash revenue = 690000

Annual operating cost = 180000

Annual dep = Cost / life of machine = 800000/4 = 200000 (No salvage value

Annual net income Before tax = Revenue - Cost - Dep = 690000-180000 -200000 = 310000

Annual net income after tax = 310000 - 40% tax

= 310000 - 124000 = 186000

Annual cash flow after tax = Net income after tax + Depreciation = 186000 + 200000 = 386000

Incremental cash flow

Particulars	Year	Old machine	New machine	Incremental (New - old)
Cost of machine	0	(600000)	(800000)	(200000)
net Cashflow after tax	1-4	174000	386000	212000
Net Cashflow after tax	5-10	174000	0	(174000)