The Fresno Finial Fabricating Works is considering automating its existing finial casting and

QUESTION

The Fresno Finial Fabricating Works is considering automating its existing finial casting and assembly department. The plant manager, Mel Content, has accumulated the following information for you: The automation proposal would result in reduced labor costs of $150,000 per year. The cost of defects is expected to remain at $5,000 even if the new automation proposal is accepted. New equipment costing $500,000 would need to be purchased. For financial reporting purposes, the equipment will be depreciated on a straight-line basis over its useful fouryear life. For tax purposes, however, the equipment falls into the three-year property class and will be depreciated using the MACRS depreciation percentages. The estimated final salvage value of the new equipment is $50,000. Annual maintenance costs will increase from $2,000 to $8,000 if the new equipment is purchased. The company is subject to a marginal tax rate of 40 percent. What are the relevant incremental cash inflows over the proposals useful life, and what is the incremental cash outflow at time 0?
incremental cash outflow at time 0 = $ -500,000 Year Cashflows Tax Savings on Depreciation Total Cashflows 0 $ -5,00,000 $ -5,00,000 1 $ 86,400 $ 66,660 $ 1,53,060 2 $ 86,400 $ 88,900 $ 1,75,300 3 $ 86,400 $ 29,620 $ 1,16,020 4 $ 86,400 $ 14,820 $ 1,01,220 Depreciation= Depreciation Rate * Cost Year Depreciation Rate Depreciation Tax savings @ 40% 1 33.33% $ 1,66,650 $ 66,660 2 44.45% $

0 $ 88,900 3 14.81% $ 74,050 $ 29,620 4 7.41% $ 37,050 $ 14,820 Incremental cashflows Savings in labor cost $ 1,50,000 less: increase in maintenance costs $ 6,000 ($ 8,000 less $ 2,000) Net Savings $ 1,44,000 less: tax @ 40% $ 57,600 Net Savings after tax $ 86,400

ANSWER:

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