3. Your firm is considering buying a new machine that costs $200,000, is expected to generate $110,000 in new revenue each year and will cost $45,000 a year to operate. If your firm's marginal income tax rate is 35% what is the Net Cash Flow your firm will realize from the new machine during the first year? Assume the MACRS depreciation rate for the machine for year 1 is 20%. Note - do not include the cost of the machine in your answer.
The net operating cash flow generated year 1 is $ 85,500.
computed as follows:
Incremental income $ 110,000
Less Depreciation 40,000 ( 20% of 200,000)
Net Income after depreciation $ 70,000
Income Tax 35% $ 24,500 ( 35% of 70,000)
Net Income after Tax 45,500
Add : depreciation 40,000
Cash Flow Generated Year 1 85,500
yes
To calculate the Net Cash Flow your firm will realize from the new machine during the first year, we need to consider the revenue generated, operating costs, and tax implications.
1. Revenue generated:
The machine is expected to generate $110,000 in new revenue each year.
2. Operating costs:
The machine will cost $45,000 per year to operate.
3. Depreciation expense:
We need to calculate the depreciation expense which will reduce the taxable income and, subsequently, the tax liability.
To do this, we'll make use of the Modified Accelerated Cost Recovery System (MACRS) depreciation method. Given that the depreciation rate for year 1 is 20%, we can determine the depreciation expense as follows:
Depreciation expense = (Initial cost of the machine) x (Depreciation rate)
= ($200,000) x (20%)
= $40,000
4. Tax implications:
The firm's marginal income tax rate is 35%. We can use this rate to calculate the tax savings resulting from the depreciation expense.
Tax savings from depreciation = (Depreciation expense) x (Marginal income tax rate)
= ($40,000) x (35%)
= $14,000
Now, let's calculate the Net Cash Flow for the first year:
Net Cash Flow = (Revenue generated) - (Operating costs) + (Tax savings from depreciation)
= ($110,000) - ($45,000) + ($14,000)
= $79,000
Therefore, the Net Cash Flow your firm will realize from the new machine during the first year is $79,000.