2C2A VERLA INDUSTRIES IS TRYING TO DECIDE WHICH ONE OF THE FOLLOWING...
247.
CSO: 2C2d
LOS: 2C2a
Verla Industries is trying to decide which one of the following two options to pursue.
Either option will take effect on January 1st of the next year.
Option One - Acquire a New Finishing Machine.
The cost of the machine is $1,000,000 and will have a useful life of five years. Net pre-
tax cash flows arising from savings in labor costs will amount to $100,000 per year for
five years. Depreciation expense will be calculated using the straight-line method for
both financial and tax reporting purposes. As an incentive to purchase, Verla will receive
a trade-in allowance of $50,000 on their current fully depreciated finishing machine.
Option Two - Outsource the Finishing Work.
Verla can outsource the work to LM Inc. at a cost of $200,000 per year for five years. If
they outsource, Verla will scrap their current fully depreciated finishing machine.
Verla’s effective income tax rate is 40%. The weighted-average cost of capital is 10%.
When comparing the two options, the $50,000 trade-in allowance would be considered
a.
irrelevant because it does not affect taxes.
b.
relevant because it is a decrease in cash outflow.
c.
irrelevant because it does not affect cash.
d.
relevant because it is an increase in cash outflows.