Cash Flow Statement: Operating and Investing Activities for an Expansion Project
A computerized machining center has been proposed for a tool-manufacturing company. If the new system (which costs $125,000) is installed, it will generate annual revenues of $100,000 and will require $20,000 in annual labor, $12,000 in annual material expenses, and another $8,000 in annual overhead (power and utility) expenses. The automation facility would be classified as a seven-year MACRS property.
The company expects to phase out the facility at the end of five years, at which time it will be sold for $50,000. Find the year-by-year after-tax net cash flow for the project at a 40% marginal tax rate, and determine the after-tax net present worth of the project at the company’s MARR of 15%.
Discussion: We can approach the problem in two steps by using the format shown in Figure 10.2 to generate an income statement and then a cash flow statement. We will follow this form in our subsequent listing of givens and unknowns. In year 0 (that is, at present) we have an investment cost of $125,000 for the equipment.^{3} This cost will be depreciated in years 1 to 5. The revenues and costs are uniform annual flows in years 1 to 5. We can see that once we find depreciation allowances for each year, we can easily compute the results for years 1 to 4, which have fixed revenue and expense entries along with the variable depreciation charges. In year 5, we will need to incorporate the salvage value of the asset and any gains tax from its disposal.
We will use the business convention that no signs (positive or negative) be used in preparing the income statement, except in the situation where we have a negative taxable income or tax savings. In that situation, we will use parentheses to denote a negative entry. However, in preparing the cash flow statement, we will explicitly observe the sign convention: A positive sign indicates a cash inflow; a negative sign or parentheses indicate a cash outflow.
