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Wilber Corporation is considering replacing a machine. The replacement will cut operating...

Question:

Wilber Corporation is considering replacing a machine. The replacement will cut operating expenses by $24,000 per year for each of the five years the new machine is expected to last.

Although the old machine has zero book value, it has a remaining useful life of five years. The depreciable value of the new machine is $72,000.

Wilbur will depreciate the machine using MACRS using a five year recovery period and is subject to 40% tax rate on ordinary income.

Estimate the incremental operating cash flows attributable to the replacement.

( Consider the depreciation in year 6.)

Operating Cash Flow:

Operating cash flow is the total cash flow generated from the core business activities. Core business activities of business include the production and selling of goods and services.

Answer and Explanation:

Compute the depreciation on new machine using MACRS using a 5-year recovery period .

Year Depreciable Value Dep. Rate Depreciation
1 $72,000.00 20% $14,400.00
2 $72,000.00 32% $23,040.00
3 $72,000.00 19.20% $13,824.00
4 $72,000.00 11.52% $8,294.40
5 $72,000.00 11.52% $8,294.40
6 $72,000.00 5.76% $4,147.20

Evaluation of incremental operating cash flows attributable to the replacement

Year Cost saving due to cut in operating exp. Tax payment at 40% on saving in operating exp. Depreciation Tax Saving at 40% on Depreciation Incremental operating cash flow
A B C D A - B + D
1 $24,000.00 $9,600.00 $14,400.00 $5,760.00 $20,160.00
2 $24,000.00 $9,600.00 $23,040.00 $9,216.00 $23,616.00
3 $24,000.00 $9,600.00 $13,824.00 $5,529.60 $19,929.60
4 $24,000.00 $9,600.00 $8,294.40 $3,317.76 $17,717.76
5 $24,000.00 $9,600.00 $8,294.40 $3,317.76 $17,717.76
6 $24,000.00 $9,600.00 $4,147.20 $1,658.88 $16,058.88

Learn more about this topic:

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Operating Cash Flow: Definition & Examples

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4
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