Introduction to Finance

Incremental After-Tax Operating Cash Flows
For a cost-saving project, it is safe to 
assume the incremental sale revenues are zero; so, if the fi rm’s revenues are $500,000, they 
will not change after the project is done. Suppose the estimated costs of operating the old 
system and the new system are as follows:
t
 = 1
t
 = 2
t
 = 3
Old computer system
$3,000
$3,500
$4,000
New computer system
$500
$2,000
$3,000
The incremental depreciation charge is the diff erence between depreciation charges on 
the new computer and those on the old one. Using straight-line depreciation, the new com-
puter’s depreciation will be its cost of $12,000 divided by three years, or $4,000 per year. The 
future depreciation of the old computer depends on the fi rm’s depreciation method selected 
at the time of purchase. Assuming the fi rm acquired the old computer two years earlier at a 
cost of $10,000, expecting a life of fi ve years, its straight-line annual depreciation charges are 
$2,000 per year.
We will assume that replacing one computer system with another will have no impact 
on the fi rm’s current assets and current liabilities. Thus, changes in net working capital 
will be zero. 
Using a 40 percent tax rate and the above information on sales, costs, depreciation, 
and net working capital, 
Table LE17.5
applies equation 17-4 to estimate operating cash 
fl ows.
TA B L E L E 1 7 . 4

Total Outlays
Cash Outflows on the New Computer
Purchase price
$7,700
Transportation
1,800
Hookup cost
200
Office modification
2,300
Total depreciable outlays
$12,000
Cash Inflows from Disposal of Old Computer
After-tax salvage value
$3,600