14. Terminal cash flow Replacement decision Russell Industries is considering re

Question

14. 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 $205,000 and will require $29,300 in installation costs. It will be depreciated under MACRS using a 5-year recovery period (see the table 1 for the applicable depreciation percentages). A $22,000 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 $13,000 before taxes, the new machine at the end of 4 years will be worth $74,000 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 Tax on sale of new machine Total after-tax proceeds-new asset Proceeds from sale of old machine Tax on sale of old machine Total after-tax proceeds-old asset Change in net working capital Terminal cash flow 1: Data Table (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 Percentage by recovery year* Recovery year 3 years 33% 45% 15% 7% years 20% 32% 19% 12% 12% 5% r years 14% 25% 18% 12% 5% 5% 5% 4% 10 years 10% 18% 14% 12% 3% 5% 7% 5% 5% 5% 4% 100% 2 4 Totals 100% 100% 100% *These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year convention

Explanation / Answer

After-tax proceeds from sale of new asset =

Proceeds from sale of new machine              $74,000

-     Tax on sale of new machine l                           (13668)

Total after-tax proceeds-new asset                                        $60,332            -           After-tax proceeds from sale of old asset

Proceeds from sale of old machine                 (13,000)

+    Tax on sale of old machine 2                               5200

Total after-tax proceeds-old asset                                            ( 7800)

+    Change in net working capital                                                      22,000

Terminal cash flow                                                                              $74532

l     Book value of new machine at end of year.4:

((1 - (0.20 + 0.32+0.19 +0 .12))*(205000+29300))          =          $39831

$74000-39831                                           =    $34169 recaptured depreciation

$34169* (0.40)                                          =    $13668 tax liability

2      Book value of old machine at end of year 4:

$0

$13,000 - $0                                              =    $13,000 recaptured depreciation

$13,000 * (0.40)                                        =    $ 5200 tax benefit

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