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Can anyone please help on this, How to find out incremental cash flow for year-2 because here answer is option b but calculated value is C.

  • 1.  Can anyone please help on this, How to find out incremental cash flow for year-2 because here answer is option b but calculated value is C.

    Posted 11-07-2020 07:29 AM
    16. CSO: 2E1b LOS: 2E1b
    Bison Inc. is considering the purchase of a new automatic machine to replace its current old fashioned machine. Bison's effective tax rate is 40%, and its cost of capital is 8%. Data regarding
    the existing and new machines are presented below.
    Existing New
    Machine Machine
    Original cost $100,000 $180,000
    Installation costs 0 25,000
    Freight and insurance 0 9,000
    Expected end salvage value 0 14,000
    Depreciation method straight-line straight-line
    Expected useful life 10 years 5 years
    The existing machine has been in service for five years and could be sold currently for $30,000.
    Bison expects to save annual pre-tax labor costs of $50,000 from the new machine.
    If the new machine is purchased, the incremental cash flows for the second year would be

    a. $18,000.
    b. $30,000.
    c. $34,000.
    d. $38,000.

    Correct answer b. Bison's second year incremental cash flow is $34,000 as shown below.

    After-tax cash savings $50,000 x .6 = $30,000
    Tax shield/new equipment ($180,000+25,000+9,000-14,000) ÷ 5 x .4 = 8,000
    - Loss of old tax shield - ($100,000 ÷ 10) x .4 = - 4,000
    Incremental Cash flow $34,000

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    . Vikesh
    Analyst
    Udupi
    India
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  • 2.  RE: Can anyone please help on this, How to find out incremental cash flow for year-2 because here answer is option b but calculated value is C.

    Posted 11-08-2020 10:31 AM
    I seem to remember this question from my studies.  Is it from Wiley's test bank or the CMA exam support package?  There's clearly an error in the tax shield calculation.  It should be calculated as $16,000, not the $8,000 as stated.

    That being the case, the answer would be $42,000, which isn't even an option.

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    Michael Ramsey
    Director/Manager
    Omaha NE
    United States
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  • 3.  RE: Can anyone please help on this, How to find out incremental cash flow for year-2 because here answer is option b but calculated value is C.

    Posted 09-04-2022 10:06 AM
    For the purpose of capital budgeting and investment analysis, the salvage value is not to be subtracted to determine the depreciable base. Quoting from the Gliem textbook " Remember that if straight-line depreciation is used for tax purposes, do not subtract the salvage value to determine the depreciable base, even though for financial reporting under U.S. GAAP the salvage value would be subtracted. The depreciable base for tax purposes is always 100% of the asset's cost, and tax depreciation is what must be used in capital budgeting"

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    Colin Pinto
    Analyst
    Mumbai
    India
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