Incremental Operating Cash Flows
Strong Tool Company has been considering purchasing a new lathe to replace a fully depreciated lathe that will last 5 more years.
The new lathe is expected to have a 5-year life and depreciation charges of $2,000 in year 1: $3,200 in year 2: $1,900 in year 3; $1,200 in both year 4 and year 5; and $500 in year 6.
The firm estimates the revenues and expenses (excluding depreciation and interest) for the new and the old lathes to be as shown in the table on the next page.
The firm is subject to a 40% tax rate.
New Lathe only
| Year | Revenue |
Expenses
(excluding depreciation and interest)
|
|
1
|
$40,000 |
$30,000 |
| 2 |
41,000 |
30,000 |
| 3 |
42,000 |
30,000 |
| 4 |
43,000 |
30,000 |
| 5 |
44,000 |
30,000 |
|
|
|
Old Lathe
| Year | Revenue | Expenses (exluding depreciation and interest) |
| 1 |
$35,000 |
$25,000 |
| 2 |
35,000 |
25,000 |
| 3 |
35,000 |
25,000 |
| 4 |
35,000 |
25,000 |
| 5 |
35,000 |
25,000 |
a) Calculate the operating cash flows associated with the new lathe. (Note: Be sure to consider he depreciation in year 6.)
b) Calculate the incremental (relevant) operating cash flows resulting from the proposed lathe replacement.
c) Depict on a time line the incremental operating cash flows calculated in part b.