EQuestion Help P11-22 (similar to Terminal cash flow Replacement decision Russel
ID: 1170505 • Letter: E
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EQuestion Help P11-22 (similar to Terminal cash flow Replacement decision Russell Industries is considering replacing a fully depreciated machine that has a remaining useful life of 10 years with a newer, more sophisticated machine. The new machine will cost $209,000 and will require $29,800 in installation costs. It will be depreciated under MACRS using a 5-year recovery period (see the table for the applicable depreciation percentages). A $26,000 increase in net working capital will be required to support the new machine. The firm's managers plan to evaluate the potential replacement over a 4-year period. They estimate that the old machine could be sold at the end of 4 years to net $14,500 before taxes; the new machine at the end of 4 years will be worth $79,000 before taxes. Calculate the terminal cash flow at the end of year 4 that is relevant to the proposed purchase of the new machine. The firm is subject to a 40% tax rate. The terminal cash flow for the replacement decision is shown below: (Round to the nearest dollar Proceeds from sale of new machine Data Table Tax on sale of new machine Total after-tax proceeds-new asset Proceeds from sale of old machine Tax on sale of old machine Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes Total after-tax proceeds-old asset Change in net working capital Terminal cash flow Percentage by recovery year 7 years 14% 25% 18% 12% 9% 9% 9% 10 years 10% 18% 14% 12% 996 8% 5 years 20% 3 years 33% 45% 15% Recovery year 19% 12% 12% 5% 6% 5% 6% Totals 100% 100% 100% 100% Enter any number in the edit fields and then click Check Answer These percentages have been rounded to the nearest whole percent to simplify calculations whileExplanation / Answer
Solution: The terminal cash flow for the replacement decision : Proceeds from sale of new Machine 79,000 Tax on sale of new Machine 15362 Total after tax proceeds new Asset 63638 Proceeds from sale of old machine 14500 Tax on sale of Old Machine 5800 Total After tax proceeds Old asset 8700 Change in net working capital 26000 Terminal cash flow 98338 Working Notes: Proceeds from sale of new Machine 79,000 a Tax on sale of new Machine 15,362 b see below Total after tax proceeds new Asset 63,638 c=a-b Proceeds from sale of old machine 14,500 d Tax on sale of Old Machine 5,800 e [14,500 x 40%] Total After tax proceeds Old asset 8,700 f=d-e Change in net working capital 26,000 g Terminal cash flow 98,338 h= c+f+g Computation depreciation on new machine New machine cost = $209,000 + $29,800 = $238,800 Year Depreciation % 5 year (a) Amount ( a x $238,800) Cum. Depreciation 1 20% 47760 47760 2 32% 76416 124176 3 19% 45372 169548 4 12% 28656 198204 5 12% 28656 226860 6 5% 11940 238800 Total 100% 238800 Tax on sale of new Machine = [sale value - (cost -depreciation till 4th) ] x 40% =(79,000 - (238,800 - 198,204) ) x 40% =(79,000 -40,596 ) x 40% =38,404 x 40% =15,361.60 =15,362 Please feel free to ask if anything about above solution in comment section of the question.
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