Case: You purchase a truck for use in your business. It will replace an older truck you currently use for the same delivery purposes but will cost less to maintain (gas & service). What are the relevant cashflows for financial analysis?
1. Determine the cashflow for 1 year . Use the following facts:
a. The New Truck Costs $100,000.
b. The IRS gives you a 10% investment tax credit and the new truck qualifies as a business investment.
c. The Old Truck is Sold for $10,000.
d. The Old Truck is fully depreciated and has no residual value - in other words it has a book value of $0
e. The capital gains tax rate is 40%.
2. Determine the cashflow for year 1. This will be the same as the cashflow for year 2, 3, 4 ... Until the truck is sold assuming everything stays the same. Use the following facts:
a. The area only difference in the expenses between the Old truck and New truck: Gasoline (the new truck is more efficient) and Depreciation (the old truck was fully depreciated).
b. The New Truck requires $3,000 in gasoline per year while the Old Truck required $5,000.
c. The New Truck will be depreciated on a S/L basis with NO residual value over 10 years. Remember that depreciation is not a cashflow but it may save on cash tax expense.
d. Depreciation and Gasoline are legitimate tax-deductible expenses for your business and you expect to make a net profit every year and can therefore use any tax deductible expense you can find.
e. NOTE: These cashflows are going to be expenses (i.e., negative) but you must compare the difference (i.e., incremental cashflows) Take into account that the after tax expenses are not the full expense. The income tax rate is 25%. So the "after tax cash flow" is equal to the Amount x (1-T). For example, if you had a sale of $10 and the tax rate was 10%, then the after tax cashflow would be $10*90% = +9. Alternatively if you had a salary expense of $1,000 the after tax cashflow would be $1,000 * (1-10%) = -900. Remember if you are looking at comparisons, if the new alternative brings in more revenues than the old, the difference will be a "positive" cashflow. Or if the new alternative reduces expenses, the difference will also be a "positive cashflow".
3. Determine the after tax cashflow for the terminal year. Use the following facts:
a. You are planning to sell the New Truck in 8 years (the terminal year) for $30,000
b. The Capital Gains Tax rate is 40% (as in part 1 above).
This solution provides a financial analysis and determines the relevant cashflows for the case provided.