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Moore Co is considering acquiring a new machine for $105,000. The machine is estimated to have a 10-year life and scrap value of $5,000. Over its life the machine is expected to produce 2,000 units each year with a sales price per unit of $500 and combined material and labour costs of $450 per unit. Tax-allowable depreciation is available on a straight-line basis on cost over five years. Moore has a 40% tax rate and tax is paid in the year of returns.
What is the after-tax cash flow for the tenth year of the project?
A.$81,000
B.$68,400
C.$63,000
D.$60,000The correct answer is C.
WORKING
$000 ————$000
Cash inflow (sales)————————— (2,000 × $500)—–1,000
Cash outflow (materials & labour)——-(2,000 × $450)——(900)
Operating cash inflow————————————————100
Tax at 40%—————————————————————(40)
Cash inflow from operations after taxes—————————60
Scrap value of equipment———————————————5
Tax on balancing charge——————(40% × $5,000)——– (2)
Cash inflow from sale of machine after taxes ——————–3
Total cash inflow after taxes——————————————63QUERY
a) I don’t understand how the solution assumes that we have to consider tax on balancing charge in year 10 whereas TAD is only available over five years. Should not it be in year 5?
Also, should they not give us a hint to consider balancing charge in year 10?
b) If an exactly similar question asked for before-tax cash flow, then would we consider tax on operating cash flow (I think, no.)? Would we consider TAD benefits?
— Thanks!
The tax on the balancing charge is considered in year 10 because the machine is sold at the end of its useful life, which is 10 years. The balancing charge arises when the asset is disposed of, and it reflects the difference between the sale proceeds and the tax written down value of the asset.
Since the machine is used for 10 years, the balancing charge is calculated at the end of this period, not at the end of the tax-allowable depreciation period (5 years).If the question asked for the before-tax cash flow, we would not consider the tax on the operating cash flow or the TAD benefits. The before-tax cash flow would simply be the operating cash inflow plus the scrap value of the equipment without any tax adjustments.
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