Homework Answers
From the question we can gather the following information:
| Purchase Cost of New Machine | $ 155,000 |
| Installation Cost | $ 19,700 |
| Increase in Net Working Capital | $ 29,600 |
| Expected Proceed Received from Disposal | $ 10,400 |
| Tax Rate | 40% |
From the above table we can calculate:
Total Cost of the new Machine = Purchase Cost of New Machine + Installation Cost
= $155,000 + $19,700
= $174,700
a) Here we have to calculate the terminal cash flow for useful life.
Option-(1)
Useful Life = 3 Years
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
| Depreciation Value | |||
| Year-1 | Year-2 | Year-3 | |
| 3 years useful life | $ 34,940 | $ 55,904 | $ 33,193 |
| Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% |
So,
Salvage value of the machine = Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193)
= $174,700 - $124,037
= $50,663
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $10,400 - $50,663
= ($40,263)
Now, we will calculate the Terminal Cash flow for useful life of 3 years:
| Legend | Formula | 3 Years | |
| Proceeds from Sale of proposed Asset | R | $ (40,263) | |
| +/- Tax on Sale of proposed Asset | T | =R*40% | $ 16,105 |
| Total after Tax proceeds | S | =R+T | $ (24,158) |
| + Change in Working Capital | NWC | $ 29,600 | |
| Terminal Cash Flow | CF | =S+NWC | $ 5,442 |
Option-(2)
Useful Life = 5 Years
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |
| 5 years useful life | $ 34,940 | $ 55,904 | $ 33,193 | $ 20,964 | $ 20,964 |
| Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% | =$174,700*12% | =$174,700*12% |
So,
Salvage value of the machine
= Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193 + $20,964 + $20,964)
= $174,700 - $165,965
= $8,735
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $10,400 - $8,735
= $1,665
Now, we will calculate the Terminal Cash flow for useful life of 5 years:
| Legend | Formula | 5 years | |
| Proceeds from Sale of proposed Asset | R | $ 1,665 | |
| +/- Tax on Sale of proposed Asset | T | =R*40% | $ (666) |
| Total after Tax proceeds | S | =R+T | $ 999 |
| + Change in Working Capital | NWC | $ 29,600 | |
| Terminal Cash Flow | CF | =S+NWC | $ 30,599 |
Option-(3)
Useful Life = 7 Years
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
| Depreciation Value | |||||||
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Year-6 | Year-7 | |
| 7 years useful life | $ 34,940 | $ 55,904 | $ 33,193 | $ 20,964 | $ 20,964 | $ 8,735 | $ - |
| Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% | =$174,700*12% | =$174,700*12% | =$174,700*5% |
So,
Salvage value of the machine
= Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193 + $20,964 + $20,964 + $8,735)
= $174,700 - $174,700
= $0
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $10,400 - $0
= $10,400
Now, we will calculate the Terminal Cash flow for useful life of 7 years:
| Legend | Formula | 7 years | |
| Proceeds from Sale of proposed Asset | R | $ 10,400 | |
| +/- Tax on Sale of proposed Asset | T | =R*40% | $ (4,160) |
| Total after Tax proceeds | S | =R+T | $ 6,240 |
| + Change in Working Capital | NWC | $ 29,600 | |
| Terminal Cash Flow | CF | =S+NWC | $ 35,840 |
b) From the finding in part (a) we can get the below mentioned information:
| Useful Life | |||||
| Legend | Formula | 3 Years | 5 years | 7 years | |
| Total Cost of a New Machine | C | $ 174,700 | $ 174,700 | $ 174,700 | |
| Total Depreciation | D | $ 124,037 | $ 165,965 | $ 174,700 | |
| Salvage Value | SV | =C-D | $ 50,663 | $ 8,735 | $ - |
| Expected Proceed Received from Disposal | P | $ 10,400 | $ 10,400 | $ 10,400 | |
| Proceeds from Sale of proposed Asset | R | =P-SV | $ (40,263) | $ 1,665 | $ 10,400 |
| +/- Tax on Sale of proposed Asset | T | =R*40% | $ 16,105 | $ (666) | $ (4,160) |
| Total after Tax proceeds | S | =R+T | $ (24,158) | $ 999 | $ 6,240 |
| + Change in Working Capital | NWC | $ 29,600 | $ 29,600 | $ 29,600 | |
| Terminal Cash Flow | CF | =S+NWC | $ 5,442 | $ 30,599 | $ 35,840 |
From the above table we can get the following observations:
- Total Depreciation value is increasing
- Salvage Value is Decreasing
- Proceeds from sale of proposed asset is increasing
- Tax Losses on proposed asset is increasing
- After Tax proceeds are increasing
- Terminal Cash Flow are increasing
So, we can see that, with increase in usable life the Terminal Cash Flow will increase.
c) Here we will calculate the Terminal Cash Floe of the machine considering 5 years usable life and different Disposal value.
Option-(1)
Useful Life = $8,735 (before Taxes)
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |
| 5 years useful life | $ 34,940 | $ 55,904 | $ 33,193 | $ 20,964 | $ 20,964 |
| Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% | =$174,700*12% | =$174,700*12% |
So,
Salvage value of the machine
= Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193 + $20,964 + $20,964)
= $174,700 - $165,965
= $8,735
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $8,735 - $8,735
= $0
Now, we will calculate the Terminal Cash flow for useful life of 5 years:
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