Principles of Managerial Finance

374 PART 3 Long-Term Investment Decisions

TABLE 8.9 Incremental (Relevant) Operating Cash

Inflows for Powell Corporation

Operating cash inflows

Incremental (relevant)

Proposed machinea Present machinea [(1)(2)]

Year (1) (2) (3)

1 $164,000 $137,520 $26,480

2 183,200 125,520 57,680

3 162,400 106,800 55,600

4 151,200 90,000 61,200

5 151,200 78,000 73,200

6 8,000 0 8,000

aFrom final row for respective machine in Table 8.8.

12. The following equation can be used to calculate more directly the incremental cash inflow in year t, ICIt.
    ICIt[PBDTt(1 T)](DtT)
    where
    PBDTtchange in profits before depreciation and taxes [revenues expenses
    (excl. depr.)] in year t
    Dtchange in depreciation expense in year t
    Tfirm’s marginal tax rate
    Applying this formula to the Powell Corporation data given in Tables 8.5 and 8.6 for year 3, we get the following
    values of variables:
    PBDT 3 ($2,520,000 $2,300,000) ($2,400,000 $2,230,000)
    $220,000$170,000$50,000

Interpreting the Term Incremental

The final step in estimating the operating cash inflows for a proposed project is

to calculate theincremental (relevant)cash inflows. Incremental operating cash

inflows are needed, because our concern isonlywith the change in operating

cash inflows that result from the proposed project.

EXAMPLE Table 8.9 demonstrates the calculation of Powell Corporation’s incremental (rele-

vant) operating cash inflows for each year. The estimates of operating cash

inflows developed in Table 8.8 are given in columns 1 and 2. Column 2 values

represent the amount of operating cash inflows that Powell Corporation will

receive if it does not replace the present machine. If the proposed machine replaces

the present machine, the firm’s operating cash inflows for each year will be those

shown in column 1. Subtracting the present machine’s operating cash inflows

from the proposed machine’s operating cash inflows, we get the incremental oper-

ating cash inflows for each year, shown in column 3. These cash flows represent

the amounts by which each respective year’s cash inflows will increase as a result

of the replacement. For example, in year 1, Powell Corporation’s cash inflows

would increase by $26,480 if the proposed project were undertaken. Clearly,

these are the relevant inflows to be considered when evaluating the benefits of

making a capital expenditure for the proposed machine.^12