Question

Operating cash inflows Afirm is considering renewing its equipment to meet increased demand for its product. The cost of equipment modifications is $1.83 million plus $115,000 in installation costs. The firm will depreciate the equipment modifications under MACRS, using a 5-year recovery period (see table 3). Additional sales revenue from the renewal should amount to $1.18 million per year, and additional operating expenses and other costs (excluding depreciation and interest) will amount to 35% of the additional sales. The firm is subject to a tax rate of 40%. (Note: Answer the following questions for each of the next 6 years.) a. What incremental earnings before depreciation, interest, and taxes will result from the renewal? b. What incremental net operating profits after taxes will result from the renewal? c. What incremental operating cash inflows will result from the renewal? Data Table a. The incremental profits before depreciation and tax are $ . (Round to the nearest dollar.) First Four Property Classes Recovery year 3 years 33% 45% 15% Percentage by recovery year 5 years 7 years 20% 14% 32% 25% 19% 12% 12% 12% 10 years 10% 18% 18% 14% 7% 12% ovo AWN- 9% Enter your answer in the answer box and then click Check Answer. 6% 4% Totals 100% 100% 100% 100% *These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year 12 parts 12 remaining

Answer 1

Additional annual revenue generated a) $1,180,000 $413,000 [Excluding depreciation & interest] Less: Additional annual operating expenses & other costs $767,000 each year Incremental earnings before depreciation, interest & taxes ($1180000 $413000) b & c) Cost of new equipment Add: Installation charges $1,830,000 $115,000 New equipment's depreciable base $1,945,000

Old equipment's 5-year MACRS table Annual Dep. Year Dep. % Base $1,945,000 $389,000 [$1945000 x 20% $1,945,000 $622,400 $1945000 x 32%] 20% 32% 2 $1945000 x 19% $1945000 x 12%] $1,945,000 $369,550 19% $1,945,000 $233,400 12% 4 $1945000 x 12% $1,945,000 $233,400 12% 5 $1,945,000 $97,250 $1945000 x 5%] 5% 6 Therefore, NOTE: EBDIT stands for earnings before depreciation, interest and taxes Year-2 Year-3 Year-1 Year-4 Year-5 Year-6 Incremental EBDIT $767,000 [Given] -$97,250 [Ref: MACRS Table] $767,000 $767,000 $767,000 $767,000 $767,000 -$233,400 $233,400 Less: Depreciation Expenses Earnings before interest & taxes Less: Taxes @ 40% -$389,000 $378,000 -$622,400 $369,550 $397,450 $533,600 $669,750 $144,600 $533,600 $213,440$13,440 $267,900 Earnings before interest and taxes x 40%] $320,160 -$151,200 $226,800 $57,840 $86,760 -$158,980 b) Operating profit after taxes Add back Depreciation Expenses c) Incremental operating cash flow $238,470 $320,160 $401,850 $389,000 $622,400 $369,550 $233,400 $553,560 $233,400 $553,560 $97,250 $499,100 [Non-cash expense and so added back] $615,800 $709,160 $608,020