Question

A company buys tracking software for its warehouse which, along with the computer system and ancillaries to run it, will cost $1.6 million. This purchase will be deducted over five years. It is expected that the software will reduce inventory by $10.7 million at the end of the first year after it is installed, though there will be an annual cost of $120,000 per year to run the system. If the company's marginal tax rate is 40%, how will the purchase of this item change the company's free cash flows in the first year

Answer 1

The company's free cash flows in the first year will be of $10.756 million

Step-by-step explanation:

In order to calculate how will the purchase of this item change the company's free cash flows in the first year we would have to calculate the following:

free cash flows = inventory reducing - aftertax annual cost + depreciation tax shield

inventory reducing = $10.7 million

aftertax annual cost = 0.12*(1-40%) = $0.072

depreciation tax shield = 1.6/5*40% = $0.128

Therefore, free cash flows =$10.7 - $0.072 + $0.128 = 10.756

free cash flows =$10.756 million

The company's free cash flows in the first year will be of $10.756 million