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  • 1.  Part 2 SU13 Q

    Posted 03-19-2023 02:28 AM

    Hi everyone, 

    I am struggling to understand the amount of relevant cash flow in the following question. 

    A company installed new equipment with a four-year useful life and no salvage value. The new equipment cost $500,000 and will generate pretax cash savings of $150,000 annually. Old equipment with a book value of $50,000 and a remaining life of two years was sold for $20,000 when the new equipment was purchased. The company uses straight-line depreciation and its effective income tax rate is 40%. The second year's relevant after-tax cash flow is

    Correct Answer: $140,000

    Annual after-tax cash saving: $90,000

    Tax shield on the depreciation of new equipment: $125,000*0,40=$50,000

    Tax shield on the depreciation of old equipment (still has two years remaining life): $50,000/2*0,40=$10,000

    So, I am finding the flow as $90,000+$50,000-$10,000=$130,000

    Could you please assist me about what I overlook in this question?

    Thank you in advance

    Ozkan Memisoglu

  • 2.  RE: Part 2 SU13 Q

    Posted 03-20-2023 01:45 AM

    Hello Ozkan,

    Question is asking only after Tax CF for the 2nd Year

    Take Annual CF After Tax (150,000*0.40)=$90,000

    Add-Dep Tax Shield =$500,000/4 Year=125,000*0.40=$50,000

    So, the Correct answer will be $140,000 CF for 2nd Year

    Hope it is clear !!!
    Note: Please note that if the question is asking CF for end of Life of Project/Terminal CF than, we will take disposal proceed..

    Israr Ali Shaikh
    [Senior Accountant]
    United Arab Emirates

  • 3.  RE: Part 2 SU13 Q

    Posted 03-20-2023 04:27 AM

    the loss on sale of old equipment is only part of the 1st year initial cash flow or year zero cash flow. it has no impact on 2nd year cash flows.. the loss on sale of old eq will be immediately recognized in full at year zero.

    Sumit Mishra
    New Delhi

  • 4.  RE: Part 2 SU13 Q

    Posted 03-20-2023 05:23 AM
    150000 pretax cash flow before dep.
    -125000 depreciation- 500k/4 years
    25000- pretax cashflow
    10000- 40%tax
    15000- after tax
    125000 add back depreciation 
    140000 cash flow

    Old equipment amount belong to initial investment so that is irrelevant