5) (35 points) Because of high operating and maintenance costs, a company is con

Question

5) (35 points) Because of high operating and maintenance costs, a company is considering a replacement for an aging machine that has been fully depreciated for tax purposes. The new machine will have an initial cost of S50,000 and is expected to generate an annual savings of S10,000 in operating and maintenance costs. Its estimated salvage value at the end of its useful life of 4 years will be $20,000. The new machine is a MACRS- GDS 3-year property for calculating depreciation deductions. The effective tax rate is 40%. Use an after-tax MARR of 10% per year compounded annually. a) (25 points) For this new machine, determine the after-tax cash flow for each year of operation. Tax ATCE b) (10 points) Use present worth analysis to determine if the company should replace the existing machine

Explanation / Answer

a.

In 4th year, salvage value is added to the cost savings.

MACRS-GDS Depreciation is added back to calculate after tax cash flow because it is a non-cash expenditure.

b.

As the present worth after replacement is negative, the machine should not be replaced.

Year Cost Benefit (Savings ) MACRS-GDS Depreciation Taxable Income Tax @40% After Tax Profit/Loss MACRS-GDS Depreciation After Tax Cash Flow 0 Initial Investment (50000) 1 10000 (16665) {33.33%} 0 0 (6665) 16665 10000 2 10000 (22225) {44.45%} 0 0 (12225) 22225 10000 3 10000 (7405) {14.81%} 2595 (1038) 1557 7405 8962 4 10000+20000=30000 (3705) {7.41%} 26295 (10518) 15777 3705 19482

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