Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The origi

Question

Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $41,000; it is now five years old, and it has a current market value of $18,000. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $20,500 and an annual depreciation expense of $4,100. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $4,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 30 percent tax rate.

What will the cash flows for this project be? (Note that the $41,000 cost of the old oven is depreciated over ten years at $4,100 per year. The half-year convention is not used for the old oven. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places.)

Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $41,000; it is now five years old, and it has a current market value of $18,000. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $20,500 and an annual depreciation expense of $4,100. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $4,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 30 percent tax rate.

Explanation / Answer

Working Note: Calculation of depreciation

Taking Rates from table

Annual Incremental Cash inflows Year 1 year 2 year 3 year 4 year 5 Cash savings from the new oven before Tax 4000 4000 4000 4000 4000 Less: Tax@ 30% 1200 1200 1200 1200 1200 Profit After Tax 2800 2800 2800 2800 2800 Add Depreciation 4000 6400 3840 2304 2304 Annual Incremental Cash Flows 6800 9200 6640 5104 5104 PV of $1 @10% 0.9091 0.8264 0.7513 0.6830 0.6209 Total PV of Cash Flows 6181.82 7603.31 4988.73 3486.10 3169.18 25429.14

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