First American is considering buying a new machine to increa

First American is considering buying a new machine to increase production. It will cost $3,000. Shipping will be $300. It has a three-year class life. At the end of one year they plan to sell the machine for $2,000. The new machine will allow FA to increase revenues by $1,800 each year but expenses will increase by $400 each year. If the new machine is purchased, inventory will decrease by $1,000 and accounts payable will increase by 350. Straight-line depreciation will be used. FA\'s marginal tax rate is 34% and its cost of capital is 7%.

What is the OCF for year 1?

$1,111

$561

$1,298

$1,950

a)		$1,111
b)		$561
c)		$1,298
d)		$1,950

Solution

Sales $      1,800 Less: Costs $         400 Depreciation $      1,100 =(3000+300)/3 EBT $         300 Less: Tax payable @ 34% $         102 Incremental earnings $          198 Add: Depreciation $      1,100 Operating cash flow $      1,298