Question

Zen Manufacturing Company is considering replacing a four-year-old machine with a new, advanced model. The old machine was purchased for $60,000, has an estimated useful life of 10 years with no salvage value, and has annual maintenance costs of $15,000. The new machine would cost $45,000, but annual maintenance costs would be only $6,000. The new machine would have an estimated useful life of 10 years with no salvage value. Using straight-line depreciation and an assumed 40% tax rate, compute the additional annual cash inflow if the old machine is replaced.

Answer 1

Answer:

$4,800

Explanation:

The computation of additional annual cash inflow is shown below:-

Saving in Annual Maintenance Cost by new machine = $15,000 - $6,000

= $9,000

Net savings on Maintenance = $9,000 × (1 - 0.4)

= $5,400

Decrease in Depreciation due to purchase of New machinery

= ($60,000 ÷ 10) - ($45,000 - 10)

= $6,000 - $4,500

= $1500  

Tax to be paid due to decrease in Depreciation = Decrease in Depreciation due to purchase of New machinery × Tax rate

= $1,500 × 0.4

= $600

Net Annual cash Inflow due to new machinery =  Net savings on Maintenance - Tax to be paid due to decrease in Depreciation

= $5,400 - $600

= $4,800

So, for computing the additional annual cash inflow we simply applied the above formula.

Answer 2

Cash flow is the movement of cash either inflow or outflow from the business. It can be either due to regular business activities those are known as operating activities. The flow of cash in other forms can be due to financing and investing activities.

The additional cash inflow is $4,800.

Computation:

$\begin{aligned}\text{Additional Cash Inflow}&=[\text{Net Savings on Maintenance}\\&-\text{Tax paid due to decrease in Depreciation}]\\&=\ 5,400-\ 600\\&=\ 4,800 \end{aligned}$

Working Note:

1. The saving in annual maintenance cost by new machine:

$\begin{aligned}\text{Saving}&=[\text{Annual Maintenance Cost of old machine}\\&-\text{Annual Maintenance Cost of new machine}]\\&=\ 15,000-\ 6,000\\&=\ 9,000 \end{aligned}$

2. Net saving on Maintenance:

$\begin{aligned}\text{Net Savings on Maintenance}&=\text{Saving}\times\left(1-\text{tax rate} \right )\\&=\ 9,000\times\left(1-0.40 \right )\\&=\ 5,400 \end{aligned}$

3. Decrease in depreciation due to purchase of new machinery:

$\begin{aligned}\text{Decrease in depreciation}&=\left(\frac{\text{Cost of old machinery}}{\text{Useful life}} \right )-\left(\frac{\text{Cost of new machinery}}{\text{Useful life}} \right )\\&=\left(\frac{\ 60,000}{10}\right)-\left(\frac{\ 45,000}{10} \right )\\&=\ 6,000-\ 4,500\\&=\ 1,500\end{aligned}$

4. Tax to be paid due to decrease in depreciation:

$\begin{aligned}\text{Tax}&=\text{Decrease in depreciation due to new machine}\times\text{tax rate}\\&=\ 1,500\times0.40\\&=\ 600 \end{aligned}$

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