Question

Operating cash inflows Strong Tool Company has been considering purchasing a new lathe to replace a fully depreciated lathe that would otherwise last 5 more years. The new lathe is expected to have a 5-year life and depreciation charges of $2,000 in Year 1, $3,200 in Year 2; $1,900 in Year 3, $1,200 in both Year 4 and Year 5, and $500 in Year 6. The firm estimates the revenues and expenses (excluding depreciation and interest) for the new and the old lathes to be as shown in the following table The firm is subject to a 40% tax rate on ordinary income. a. Calculate the operating cash inflows associated with each lathe. (Note: Be sure to consider the depreciation in year 6.) b. Calculate the operating cash inflows resulting from the proposed lathe replacement. c. Depict on a time line the incremental operating cash inflows calculated in part b.

Answer 1

a. Operating Cash Inflows = EBITDA * ( 1 - t ) + Depreciation * t

EBITDA = Revenue - Expenses ( excluding depreciation and interest )

Year	New Lathe	Old Lathe
	EBITDA	Depreciation	Operating Cash Inflows	EBITDA	Depreciation	Operating Cash Inflows
1	$ 10,000	$ 2,000	$ 6,800	$ 10,000	$ 0	$ 6,000
2	11,000	3,200	7,880	10,000	0	6,000
3	12,000	1,900	7,960	10,000	0	6,000
4	13,000	1,200	8,280	10,000	0	6,000
5	14,000	1,200	8,880	10,000	0	6,000
6	0	500	200	0	0	0

b.

	1	2	3	4	5	6
Operating Cash Inflows from New Lathe	6,800	7,880	7,960	8,280	8,880	200
Less: Operating Cash Inflows from Old Lathe	6,000	6,000	6,000	6,000	6,000	-
Operating Cash Inflows from the Proposed Lathe Replacement	800	1,880	1,960	2,280	2,880	200