Incremental operating cash flows Richard and Linda Thomson operate a local lawn
ID: 2631419 • Letter: I
Question
Incremental operating cash flows Richard and Linda Thomson operate a local lawn
maintenance service for commercial and residential property. They have been using
a John Deere riding mower for the past several years and believe that it is time to
buy a new one. They would like to know the incremental (relevant) cash flows
associated with the replacement of the old riding mower. The following data are
available:
There are 5 years of remaining useful life on the old mower.
The old mower has a zero book value.
The new mower is expected to last 5 years.
The Thomsons will follow a 5-year MACRS recovery period for the new mower.
Depreciable value of the new mower is $1,800.
They are subject to a 40% tax rate.
The new mower is expected to be more fuel efficient, maneuverable, and durable
than previous models and can result in reduced operating expenses of $500 per year.
The Thomsons will buy a maintenance contract that calls for annual payments
of $120.
Create an incremental operating cash flow statement for the replacement of Richard
and Linda
Explanation / Answer
Depreciable Cost of the Mower $1,800 Depreciation Schedule: Year Depreciable Cost Depreciation Rate Annual Depreciation Accumulated Depreciation Book value 1 $1,800 20% $360 $360 $1,440 2 $1,800 32% $576 $936 $864 3 $1,800 19% $342 $1,278 $522 4 $1,800 12% $216 $1,494 $306 5 $1,800 12% $216 $1,710 $90 6 $1,800 5% $90 $1,800 $0 Year 1 2 3 4 5 6 Incremental Expense Savings $500 $500 $500 $500 $500 $0 Less: Annual Maintenance Payments $120 $120 $120 $120 $120 $0 Incremental Profits before Dep. & Taxes $380 $380 $380 $380 $380 $0 Less: Depreciation $360 $576 $342 $216 $216 $90 Net Profits before Taxes $20 ($196) $38 $164 $164 ($90) Less: Taxes @ 40% $8.0 ($78.4) $15.2 $65.6 $65.6 ($36.0) Net Profits after Taxes $12.0 ($117.6) $22.8 $98.4 $98.4 ($54.0) Operating Cash Inflows $372.0 $458.4 $364.8 $314.4 $314.4 $36.0