Answer:
$720,000
Step-by-step explanation:
To calculate the incremental free cash flows associated with the new machine in year 3, we need to consider the cash inflows and outflows specific to that year. Let's break it down step by step:
1. Calculate the annual gross profit: The machine is expected to generate a gross profit of $1,500,000 per year, starting from the end of the first year.
2. Calculate the annual costs: The costs associated with the machine are $0.5 million per year.
3. Calculate the annual net profit: Subtract the annual costs from the gross profit to get the net profit for each year.
Annual net profit = Annual gross profit - Annual costs
Annual net profit = $1,500,000 - $0.5 million = $1,000,000
4. Calculate the depreciation expense: The machine will be depreciated over 10 years using the straight-line method. The total depreciation expense is the initial cost of the machine divided by its useful life.
Depreciation expense = Cost of the machine / Useful life
Depreciation expense = $2,000,000 / 10 = $200,000 per year
5. Calculate the taxable income: Subtract the depreciation expense from the net profit to calculate the taxable income.
Taxable income = Annual net profit - Depreciation expense
Taxable income = $1,000,000 - $200,000 = $800,000
6. Calculate the taxes: Apply the marginal tax rate of 35% to the taxable income.
Taxes = Taxable income * Marginal tax rate
Taxes = $800,000 * 0.35 = $280,000
7. Calculate the net cash flow before tax: Subtract the taxes from the net profit to calculate the net cash flow before tax.
Net cash flow before tax = Annual net profit - Taxes
Net cash flow before tax = $1,000,000 - $280,000 = $720,000
8. Calculate the incremental free cash flow: Deduct any additional cash outflows and add any cash inflows specific to year 3.
Incremental free cash flow = Net cash flow before tax - Additional cash outflows + Additional cash inflows
In this case, there is no specific information given about additional cash outflows or inflows in year 3, so the incremental free cash flow in year 3 would be equal to the net cash flow before tax:
Incremental free cash flow = $720,000
Therefore, the correct answer is $720,000.