Question

Nokela Industries purchases a $38.8 million​ cyclo-converter. The​ cyclo-converter will be depreciated by $9.7 million per year over four​ years, starting this year. Suppose​ Nokela's tax rate is 40%. What impact will the cost of the purchase have on earnings for each of the next four​ years? What impact will the cost of the purchase have on the​ firm's cash flow for the next four​years?

Answer 1

The cost of the purchase will reduce the earnings of Nokela Industries by $5.82 million each year for the next four years. The firm's cash flow will also be reduced by $9.7 million annually until the cyclo-converter is fully depreciated.

Step-by-step explanation:

The cost of the purchase will have an impact on earnings for each of the next four years. The annual depreciation expense of $9.7 million will be deducted from Nokela Industries' earnings before taxes. The tax rate is 40%, so the tax expense will be $3.88 million ($9.7 million x 40%).

Therefore, the cost of the purchase will reduce Nokela Industries' earnings by $5.82 million ($9.7 million - $3.88 million) each year for the next four years.

As a result, the cash outflow for depreciation will be $9.7 million each year for the next four years. This will reduce the firm's cash flow by $9.7 million annually until the cyclo-converter is fully depreciated.