Vusi and Fezeka Msimang operate a local lawn maintenance service for commercial and residential property. They have been using a John Deere riding mower for the past several years and feel it is time to buy a new one. They would like to know the incremental (relevant) cash flows associated with the replacement of the old riding mower. The following data are available:
There are five years remaining life of the old mower.
The old mower has a zero book value.
The new mower is expected to last five years.
The Msimangs will be allowed to depreciate the new mower over a 5-year straight-line period.
Depreciable value of the new lawn mower is R18 000.
They are subject to a 30% tax rate.
The new mower is expected to be more fuel efficient, maneuverable and durable than the previous models and can result in reduced operating expenses of R5 000 per year.
The Msimangs will buy a maintenance contract that calls for annual payments of R6 000 in year 1 and which will increase by 10% per year thereafter.
Create an incremental operating cash flow statement for the replacement of Vusi and Fezeka's John Deere riding mower. Show the incremental operating cash flow for the next five years.
This solution illustrates how to create an incremental cash flow statement.