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    Accounting Income Versus Cash Flows

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    Please help with the following problem.

    "Over sufficiently long time periods, net income equals cash inflows minus cash outflows, other than cash flows with owners."

    Demonstrate the accuracy of this statement in this scenario:

    Two friends contribute $50,000 each to form a new business. The owners used the amounts contributed to purchase a machine for $100,000 cash. They estimated that the useful life of the machine was five years and the salvage value was $20,000. They rented out the machines to a customer for an annual rental of $25,000 a year for five years. Annual cash operating costs for insurance, taxes and other items totaled $6,000 annually. At the end of the fifth year, the owners sold the equipment for $22,000, instead of the $20,000 salvage value initially estimated.

    Compute the total net income and the total cash flows other than cash flows with owners for the five-year period as a whole.

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    Solution Summary

    This solution illustrates the computation of net income versus the computation of cash flows from operating activities.