Operating cash flow (OCF) is a measure of the amount of cash generated by a company's normal business operations. The document provides formulas to calculate OCF and uses them to solve an example problem. It calculates the change in revenues, expenses, and depreciation with and without a proposed new machine investment. Using the formulas, it then determines the OCF for each of the 5 years after purchasing the new machine.

1. OPERATING CASH FLOW
Wasif Ali Syed (18221554-001)

2. WHAT IS OPERATING CASH FLOWS?
• Operating cash flow (OCF) is a measure of the amount of cash generated by a
company's normal business operations. Operating cash flow indicates whether a
company can generate sufficient positive cash flow to maintain and grow its
operations, otherwise, it may require external financing for capital expansion.

3. FORMULAS FOR CALCULATION OF
OPERATING CASH FLOWS
• OCF= (Δ EBIT)(1 – tax rate) + Δ Depreciation
• OCF= (Δ EBDIT – Δ Depreciation)(1 – tax rate) + Δ Depreciation
• OCF= (Δ Revenues – Δ Expenses – Δ Depreciation)(1 – tax rate) + Δ Depreciation
• Where as:
• Δ Revenues= Revenues with project (new asset) - Revenues without project (old asset)
• Δ Expenses= Expenses with project (new asset) - Expenses without project (old asset)
• Δ Depreciation= Depreciation with project (new asset) - Depreciation without project (old asset)

4. QUESTION
Year Revenues Expenses
1 1400,000 1375,000
2 1450,000 1400,000
3 1500,000 1420,000
4 1500,000 1400,000
5 1380,000 1370,000
• Question: Jack Corporation has planned to replace its old machine with new one and desires to determine
operating cash flows. The purchase price of new machine is $300,000 and installation cost is $20,000. New machine
will be depreciated under 5 years MACRS. The old machine was acquired 3 years ago at a cost of $200,000, is being
depreciated using 5 years MACRS and can be used for next 5 years. The estimates of its revenue and expenses
(excluding depreciation and interest), with and without the proposed new machine are given below (tax rate=40%):
with proposed machine with new machine
Year Revenues Expenses
1 1800,000 1500,000
2 1830,000 1520,000
3 1880,000 1550,000
4 1820,000 1515,000
5 1770,000 1475,000

5. SOLUTION
Δ Revenues= Revenues with project (new asset) - Revenues without project (old asset)
• Year 1=1,800,000 – 1,400,000= 400,000
• Year 2=1,830,000 – 1,450,000= 380,000
• Year 3=1,880,000 – 1,500,000= 380,000
• Year 4=1,820,000 – 1,500,000= 320,000
• Year 5=1,770,000 – 1,380,000= 390,000
Δ Expenses= Expenses with project (new asset) - Expenses without project (old asset)
• Year 1=1,500,000 – 1,375,000= 125,000
• Year 2=1,520,000 – 1,400,000= 120,000
• Year 3=1,550,000 – 1,420,000= 130,000
• Year 4=1,515,000 – 1,400,000= 115,000
• Year 5=1,475,000 – 1,370,000= 105,000

6. SOLUTION
Δ Depreciation= Depreciation with project (new asset) - Depreciation without project (old asset)
• Year 1 =64,000 – 23,040= 40,960
• Year 2 =102,400 – 23,040= 79,360
• Year 3 =61,440 – 11,520= 49,920
• Year 4 =36,864 – 0= 36,864
• Year 5 = 36,864 – 0= 36,864
Depreciation New asset Depreciation old asset
• Year 5 years Depreciation Exp.=Asset cost x dep. Rate Depreciation Exp.=Asset cost x dep. Rate
• 1 20% =320,000 x 0.20= 64,000 =200,000 x 0.20= 40,000
• 2 32 =320,000 x 0.32= 102,400 =200,000 x 0.32= 64,000
• 3 19.2 =320,000 x 0.192= 61,440 =200,000 x 0.192= 38,400
• 4 11.52 =320,000 x 0.1152= 36,864 =200,000 x 0.1152= 23,040
• 5 11.52 =320,000 x 0.1152= 36,864 =200,000 x 0.1152= 23,040
• 6 5.76 =320,000 x 0.0576= 18,432 =200,000 x 0.0576= 11,520

7. SOLUTION
OCF= (Δ Revenues – Δ Expenses – Δ Depreciation)(1 – tax rate) + Δ Depreciation
• Year 1= (400,000 – 125,000 – 40,960)(1 – 0.4) + 40,960= 181,384
• Year 2= (380,000 – 120,000 – 79,360)(1 – 0.4) + 79,360= 187,744
• Year 3= (380,000 – 130,000 – 49,920)(1 – 0.4) + 49,920= 169,968
• Year 4= (320,000 – 115,000 – 36,864)(1 – 0.4) + 36,864= 137,746
• Year 5= (390,000 – 105,000 – 36,864)(1 – 0.4) + 36,864= 185,746