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Last year, Michelson Manufacturing reported $10,250 of sales, $3,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges, it had $3,500 of bonds outstanding that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 21%. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $725. By how much will the depreciation change cause the firm's net after-tax income and its net cash flow to change

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Answer and Explanation:

The computation is shown below:

Particulars                       Last year            Current year

Sales                               $10,250              $10,250

Operating cost               -$3,500              -$3,500

Operating income           $6,750               $6,750

less:

Interest expense

(6.5% of 3,500)               -$227.50           -$227.50

depreciation expense   -$1,250               -$1,975  ($1,250 + $725)

Earning before tax           $5,272.50          $4,547.50

Less: Income tax

at 21%                              -$1,107.23           -$954.98

Net income                      $4,165.27            $3,592.53

Now the net cash flow is

Net income                       $4,165.27             $3,592.53

Add:

Depreciation                      $1,250                 $1,975

Total net cash flows           $5,145.27          $5,567.53

Change is $422.26

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