Question

You are evaluating the purchase for a manufacturing machine; the price is $120,000 and it will save company $50,000 of expenses every year. The machine is depreciated using three-year straight-line schedule and will be sold after that for $50,000. The project would have no effect on revenues, and the corporate tax rate is 30%. What is the project’s after-tax cash flow in Year 3?

(A)	$35,000.
(B)	$47,000.
(C)	$60,000.
(D)	$70,000.
(E)	$82,000.

2. Using the same information from previous question (Question 15). The machine will be sold for $50,000 after three years. What is the Year 3 after-tax cash flow if the machine is depreciated using MACRS 3-year class where the applicable depreciation rates are 33%, 45%, 15% and 7%.

(A)	$26,600.
(B)	$61,600.
(C)	$69,520.
(D)	$75,400.
(E)	$77,920.

Answer 1

1)	(E)	$       82,000
Working:
Step-1:Calculation of after tax operating cash flow
Saving of expense		$       50,000
Depreciation		$     -40,000
Profit before tax		$       10,000
Tax Expense		$        -3,000
Net Income		$         7,000
Depreciation		$       40,000
After tax operating cash flow		$       47,000
Step-2:After tax cash flow from sale of asset
After tax cash flow from sale of asset	=	Before tax sale *(1- Tax rate)
	=	50000*(1-0.30)
	=	$       35,000
Working:
Depreciation expense	=	Cost / Useful Life
	=	120000/3
	=	$       40,000
Step-3:After tax cash flow in year 3
Operating cash flow		$       47,000
Terminal Cash flow		$       35,000
Cash flow in year 3		$       82,000
2)	(E)	$       77,920
Working:
Step-1:Calculation of after tax operating cash flow
Saving of expense		$       50,000
Depreciation		$     -18,000
Profit before tax		$       32,000
Tax Expense		$        -9,600
Net Income		$       22,400
Depreciation		$       18,000
After tax operating cash flow		$       40,400
Step-2:After tax cash flow from sale of asset
After tax cash flow from sale of asset	=	Before tax sale *(1- Tax rate)
	=	50000-((50000-8400)*0.30)
	=	$       37,520
Working:
Depreciation Schedule:
Year	Cost	Depreciation rate	Depreciation expense	Accumulated Depreciation expense	Book Value
1	$       1,20,000	33%	$ 39,600	$     39,600	$ 80,400
2	$       1,20,000	45%	$ 54,000	$     93,600	$ 26,400
3	$       1,20,000	15%	$ 18,000	$ 1,11,600	$    8,400
Step-3:After tax cash flow in year 3
Operating cash flow		$       40,400
Terminal Cash flow		$       37,520
Cash flow in year 3		$       77,920