Operating Cash Inflows - Strong Tool Company

Strong Tool Company is considering purchasing a new lathe to replace a fully depreciated lathe that would otherwise last 5 more years. The new lathe is expected to have a 5-year life with depreciation charges as follows: $2,100 in Year 1, $3,360 in Year 2, $1,995 in Year 3, $1,260 in Year 4, $1,260 in Year 5, and $525 in Year 6. The firm estimates the revenues and expenses (excluding depreciation and interest) for the new and the old lathes as shown in the data table. The firm is subject to a 40% tax rate on ordinary income.

Tasks:
a. Calculate the operating cash inflows associated with each lathe. (Note: Be sure to consider the depreciation in Year 6.)
b. Calculate the operating cash inflows resulting from the proposed lathe replacement.
c. Depict on a timeline the incremental operating cash inflows calculated in part b.

Data Table:

New Lathe:
- Year: 1, 2, 3, 4, 5
- Revenue: $41,500, $42,500, $43,500, $44,500, $45,500
- Expenses (excluding depreciation and interest): $31,500 for each year

Old Lathe:
- Year: 1, 2, 3, 4, 5
- Revenue: $36,500 for each year
- Expenses (excluding depreciation and interest): $25,400 for each year

Steps to Complete:
1. Calculate the operating cash inflows for both the new and old lathes, considering the depreciation and tax effects.
2. Determine the incremental operating cash inflows from the lathe replacement.
3. Illustrate the incremental cash inflows on a timeline.

- New Lathe: Calculate the net profit after taxes by subtracting the expenses (excluding depreciation and interest) from the revenue for each year, adding back the depreciation expense, and applying the tax rate. The resulting values represent the operating cash flows for the new lathe.

b) The operating cash inflows resulting from the proposed lathe replacement are the differences in operating cash flows between the new lathe and the old lathe for each year. These differences represent the incremental cash flows associated with the lathe replacement.

c) To depict the incremental operating cash inflows on a timeline, you would plot the differences in operating cash flows between the new lathe and the old lathe for each year. This timeline helps visualize the changes in cash flows over time due to the lathe replacement decision.

a) The operating cash inflows associated with each lathe are calculated by determining the net profit before taxes for each year and then adjusting for depreciation and taxes to arrive at the operating cash flows.

For the new lathe:

- Calculate the net profit before taxes by subtracting the expenses (excluding depreciation and interest) from the revenue for each year.

- Subtract the depreciation expense for each year to account for the reduction in the value of the lathe over time.

- Apply the tax rate (40%) to calculate the taxes payable on the net profit before taxes.

- Subtract the taxes from the net profit before taxes to arrive at the net profit after taxes, which represents the operating cash flow for each year.

b) The operating cash inflows resulting from the proposed lathe replacement are determined by taking the differences in operating cash flows between the new lathe and the old lathe for each year. This comparison helps assess the incremental cash flows that would be generated if the old lathe is replaced with the new lathe.

c) To depict the incremental operating cash inflows on a timeline, you would plot the differences in operating cash flows between the new lathe and the old lathe for each year. This timeline provides a visual representation of how the cash flows would change over time if the lathe replacement decision is implemented. It helps in assessing the financial impact and the timing of the incremental cash flows resulting from the replacement.

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