Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement

Question

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset will be depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.

Explanation / Answer

Book value of exixting equipment = 25000%(1-(20%+32%+19.2%))= 7200

After tax salvage value = 10000- (10000-7200)*40%= 8880

0 1 2 3 4 5 Initial Cost+Installation -53000 After tax salvage value of existing equipment 8880 net profits 15000 15000 15000 15000 15000 Depreciation % 20% 32% 19.20% 11.52% 11.52% Depreciation 10600 16960 10176 6105.6 6105.6 After tax salvage value of new equipment 3052.8 Relevant Cash flows -44120 25600 31960 25176 21105.6 24158.4

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