A firm is considering purchasing a machine that costs $80,000. It will be used f

Question

A firm is considering purchasing a machine that costs $80,000. It will be used for six years, and the salvage value at that time is expected to be zero. The machine will save $37,000 per year in labor, but it will incur $16,000 in operating and maintenance costs each year. The machine will be depreciated according to five-year MACRS. The firm's tax rate is 35%, and its after-tax MARR is 16%. Should the machine be purchased? Click the icon to view the MACRS depreciation schedules The present worth of the project is $1 (Round to the nearest dollar.)

Explanation / Answer

Woking notes:

(1) MACRS Depreciation schedule assuming 5 year property class:

(2) Before tax cash flow (BTCF) ($) = Annual labor savings - Annual operating cost = 37,000 - 16,000 = 21,000

(3) Taxable income (TI) = BTCF - Annual MACRS depreciation

(4) Net income (NI) = TI x (1 - Tax rate) = TI x (1 - 0.35) = TI x 0.65

(5) After-tax cash flow (ATCF) = NI + Annual MACRS depreciation

(In year 0, ATCF = - $80,000)

ATCF and its Present Worth are computed as follows.

Since Present Worth is positive, Machine should be purchased.

Year Cost ($) Annual Depreciation Rate (%) Annual Depreciation ($) (A) (B) (C) = (A) x (B) 1 80,000 20 16,000 2 80,000 32 25,600 3 80,000 19.2 15,360 4 80,000 11.52 9,216 5 80,000 11.52 9,216 6 80,000 5.76 4,608

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