[jgmart04]

Why would you include transportation and installation as a apart of the 5 year depreciation?

The Moore Corporation is considering the acquisition of a new machine. The machine can be purchased for $90,000; it will cost $6,000 to transport to Moore’s plant and $9,000 to install. It is estimated that the machine will last 10 years, and it is expected to have an estimated salvage value of $5,000. Over its 10-year life, the machine is expected to produce 2,000 units per year with a selling price of $500 each and combined material and labor costs of $450 per unit. Federal tax regulations permit machines of this type to be depreciated using the straight-line method over five years with no estimated salvage value. Moore has a marginal tax rate of 40%.

What is the net cash flow for the third year that Moore Corporation should use in a capital budgeting analysis?

A.
$68,400

B.
$68,000

C.
$64,200

D.
$53,700

Answer is A

The net cash flow for the third year that Moore Corporation should use in a capital budgeting analysis should include net cash inflow expected from the sale and production of 2,000 units less tax on income. In calculating tax, one should remember to consider depreciation. Although depreciation is not a cash outflow, it does reduce the amount of income upon which tax is calculated.

Inflow = 2000 units x ($500 – $450) = $100,000

Outflow (tax): = Income from production = $100,000
Less depreciation = (21,000)*
——–
Operating income = $ 79,000
x Tax rate x .40
——–
= Tax $ 31,600
========

Net cash flow = $100,000 – 31,600 = $68,400

* Depreciation = ($90,000 + $6,000 + $9,000) / 5 = $21,000
Note: The problem specifically states that the federal regulation used does not recognize salvage value.