Question

YZ Company’s machine was purchased 5 years ago for $55,000. It had an expected life of 10 years when it was bought, and its remaining depreciation is $5,500 per year for each year of its remaining life and can be sold for $20,000 at the end of its useful life. A new machine can be purchased for $120,000, including the installation costs. During its 5-year life, it will reduce cash operating expenses by $30,000 per year. Sales revenue will not be affected. At the end of its useful life, the machine is estimated to be sold at $10,000. We will use MARCS depreciation, and the machine will be depreciated over its 5-year property class life. The old machine can be sold today for $35,000.

*The tax rate is 25%

*WACC is 16%

a) what is the amount of the initial cash flow at Year 0 if the new machine is purchased?

b)Calculate the after-tax salvage value of the new machine at the end of the project?

c)Calculate the incremental cash flows that will occur at the end of years 1-5?

*Use excel cell reference for the questions for the above questions

Answer 1

Time line		0	1	2	3	4	5
Proceeds from sale of existing asset	=selling price* ( 1 -tax rate)	26250
Tax shield on existing asset book value	=Book value * tax rate	6875
Cost of new machine		-120000
=a. Initial Investment outlay		-86875
5 years MACR rate			20.00%	32.00%	19.20%	11.52%	11.52%
Savings			30000	30000	30000	30000	30000
-Depreciation	=Cost of machine*MACR%		-24000	-38400	-23040	-13824	-13824
=Pretax cash flows			6000	-8400	6960	16176	16176
-taxes	=(Pretax cash flows)*(1-tax)		4500	-6300	5220	12132	12132
+Depreciation			24000	38400	23040	13824	13824
=after tax operating cash flow			28500	32100	28260	25956	25956
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						7500
+Tax shield on salvage book value	=Salvage value * tax rate						1728
=b. Terminal year after tax cash flows							9228
c. Total Cash flow for the period			28500	32100	28260	25956	35184