Al's Fabrication Shop is purchasing a new rivet machine to replace an existing one.The new machine costs $8000 and will require an additional cost of $1000 for modification and training.It will be depreciated using simplified straight line depreciation over five years.The new machine operates much faster than the old machine and with better quality.Consequently, sales are expected to increase by $2100 per year for the next five years.While it is faster, it is fully automated and will result in increased electricity costs for the firm by $700 per year.It will, however, save about $850 per year in labor costs.The old machine is 20 years old and has already been fully depreciated.If the firm's marginal tax rate is 28%, calculate the after tax incremental cash flows for the new machine for years 1 through 5.
A)$2698
B)$450
C)$2124
D)$1620

Question

Quizplus · Accepted Answer

Year 1: 
Incremental Revenue = $2,100 
Incremental Expenses: 
Electricity cost = ($700) 
Labor cost savings = $850 
Depreciation = ($1,600) [($8,000 + $1,000) / 5] 
Tax Savings on Depreciation = $448 ($1,600 x 28%) 
Net incremental cash flow for year 1 = $2,098 [$2,100 - $700 - $850 - $1,600 + $448]

Year 2-5: 
Incremental Revenue = $2,100 
Incremental Expenses: 
Electricity cost = ($700) 
Labor cost savings = $850 
Depreciation = ($1,600) [($8,000 + $1,000) / 5] 
Tax Savings on Depreciation = $448 ($1,600 x 28%) 
Net incremental cash flow for year 2-5 = $2,098 [$2,100 - $700 - $850 - $1,600 + $448] x 4 = $8,392

Total after-tax incremental cash flows for the new machine for 5 years = $10,490 ($2,098 + $8,392)

Since the total after-tax incremental cash flows are positive, the new machine is a good investment.

Al's Fabrication Shop Is Purchasing a New Rivet Machine to Replace