Student Forums CMA Part 2 Section E: Investment Decisions E.1. Capital Budgeting Process Question ID: ICMA 1603.P2.069 (Topic: Capital Budgeting

Question ID: ICMA 1603.P2.069 (Topic: Capital Budgeting

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  • #221861
    Vineetha Nair
    Participant

    Hi,

    In the given question why are we adjusting the existing machinery’s depreciation with the new machinery’s depreciation to arrive at the depreciation tax shield? It’s mentioned that the existing machine is sold while purchasing the new one, which would have happened in Year 0, then why the depreciation is adjusted in calculating year 2 relevant cash flow?

    Please advise.

    Thanks

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  • #221862
    Lynn Roden
    HOCK international

    Hi Vineetha,

    In this question a new machine is replacing an old machine, so it is an incremental analysis. The cash flows used in the capital budgeting analysis are incremental cash flows, or the amount of difference in the cash flow caused by replacing the old machine with the new machine.

    Please refer to your CMA Part 2, Vol. 2 book for more information. Please see “Incremental Analysis: A New Asset Replacing an Old Asset” and also “Appendix C – An Incremental Capital Budgeting Analysis” in that book.

    Lynn

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