Question

Daily Enterprises is purchasing a $10.2 million machine. It will cost $45,000 to transport and install the machine. The machine has a depreciable life of five years and will have no salvage value. The machine will generate incremental revenues of $3.8 million per year along with incremental costs of $1.3 million per year. If Daily's marginal tax rate is 35%, what are the incremental earnings (net income) associated with the new machine? The annual incremental earnings are $ . (Round to the nearest dollar.)

Answer 1

Purchase cost of machine = $10,200,000
Transportation and Installation cost = $ 45,000
Therefore,
Total cost of the machine = $10,200,000 + $ 45,000 = $ 10,245,000

Depreciable life = 5 years
Therefore, Depreciation per year = Total cost / depreciable life
= 10,245,000 / 5 = $ 2,049,000
Therefore annual depreciation cost = $ 2,049,000

Incremental revenue per year = $3,800,000
Incremental cost per year = $ 1,300,000
Tax Rate = 35%

Below table reflect each years cash flows and the incremental income:

	Year 1	Year 2	Year 3	Year 4	Year 5
Incremental Revenue of Machine	3,800,000	3,800,000	3,800,000	3,800,000	3,800,000
Incremental Cost of Machine	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000
Depreciation	2,049,000	2,049,000	2,049,000	2,049,000	2,049,000
Total Incremental Cost of Machine	3,349,000	3,349,000	3,349,000	3,349,000	3,349,000
Incremental Income before Tax (Inc Revenue - Total Inc Cost)	451,000	451,000	451,000	451,000	451,000
Tax @ 35%	157,850	157,850	157,850	157,850	157,850
Net Incremental Income after deducting tax	293,150	293,150	293,150	293,150	293,150

Below table explains the incremental cash flow due to the project. Since depreciation is a non cash expenditure, it should be added back as there is no actual cash outflow.

	Year 1	Year 2	Year 3	Year 4	Year 5
Incremental Income after Tax	293,150	293,150	293,150	293,150	293,150
Depreciation	2,049,000	2,049,000	2,049,000	2,049,000	2,049,000
Incremental Cash flow	2,342,150	2,342,150	2,342,150	2,342,150	2,342,150