If a firm replaces an old machine they expect to save $5,000 per year in operati

Question

If a firm replaces an old machine they expect to save $5,000 per year in operating costs. Depreciation expense will be $2,000 per year. The old machine was fully depreciated. The firm's tax rate is 35%. The new machine costs $8,000. The new machine is expected to last about 4 years at which time it will be worthless and have to be replaced. The required return for these types of projects is 10%. What are the incremental operating cash flows of this replacement project?

I have the answer, but I need a step by step guide on how to do the problem.

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Incremental Operating Cash Flow = (Annual Savings - Depreciation)*(1-Tax Rate) + Depreciation = (5000 - 2000)*(1-35%) + 2000 = $3950

Initial Year Cash Outflow =-8000

Annual Incremental Operating Cash Flow = $3950

Thanks.

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