# Next we compute the annual cash from years 1 5 cash

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Next we compute the annual cash from years 1 5 Cash Next we compute the annual cash from years 1-5. Cash Flows for years 1-4 will be the same. S TEP 3: S OLVE Analysis of Annual Cash Inflows Years 1-4 Year 5 Increase in operating income \$20,000 \$20,000 Reduced salaries \$100,000 \$100,000 Reduced defects \$50,000 \$50,000 Reduced fringe benefits \$10,000 \$10,000 Total cash inflows \$180,000 \$180,000 S TEP 3: S OLVE Analysis of Annual Cash Out Flows Years 1-4 Years 5 Increased maintenance -\$40,000 -\$40,000 Increased depreciation -\$50,000 -\$50,000 Net operating income \$90,000 \$90,000 Less: Taxes -\$27,000 -\$27,000 Net operating profit after taxes \$63,000 \$63,000 Plus: depreciation \$50,000 \$50,000 Operating cash flow \$113,000 \$113,000 Less: Change in operating working capital \$20,000 Less: CAPEX 50,0000 Free Cash Flows \$113,000 \$183,000

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25 S TEP 4: A NALYZE In this case, we observe that the new machine generated cost savings and also increased the revenues by \$20,000. Based on the estimates of initial cash outflow and subsequent annual free cash flows for years 1-5, we can compute the NPV. C OMPUTING NPV Continue Checkpoint 12.2: Check Yourself example . Compute the NPV for this replacement project based on discount rate of 15%. C OMPUTING NPV NPV can be easily computed using mathematical equation (11-1): NPV = -\$285,000 + \$113,000/(1.15) 1 + \$113,000/(1.15) 2 + \$113 000/(1 15) 3 + \$113 000/(1 15) 4 + \$183 000/(1 15) 5 + \$113,000/(1.15) + \$113,000/(1.15) + \$183,000/(1.15) = \$128,595.90

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