You must evaluate a proposal to buy a new milling machine. The base price is $10
ID: 2661521 • Letter: Y
Question
You must evaluate a proposal to buy a new milling machine. The base price is $108,000, and shipping and installation costswould add another $12,500. The machine falls into the MACRS3-year class, and it would be sold after 3 years for $65,000. The applicable depreciation rates are 33, 45, 15 and 7 percent asdiscussed in Appendix 12A of your text book. The machinewould require a $5,500 increase in working capital (increasedinventory less increased accounts payable). There would be noeffect on revenues, but pre-tax labor costs would decline by$44,000 per year. The marginal tax rate is 35 percent, andthe WACC is 12 percent. Also, the firm spent $5,000 last yearinvestigating the feasibility of using the machine.
What are the net operating cash flows during Years 1, 2and 3?
Explanation / Answer
Year 1
Year 2
Year 3
After-tax Cost Savings = $44,000(1-T) = $44,000 (1-0.35) = $28,600 After-tax Cost Savings =$28,600 Calculating Depreciation AmountUsing MACRS 3-Year clss: Depreciation expenses in 1styear = ($108,000 + $12,500) * 0.33 = $39,765 Tax-savings onDepreciation = $39,765 * 0.35 Tax-savings onDepreciation = $13,917.75 Depreciation expenses in 1styear = ($108,000 + $12,500) * 0.45 = $54,225 Tax-savings onDepreciation = $54,225 * 0.35 Tax-savings onDepreciation = $18,978.75 Depreciation expenses in 1styear = ($108,000 + $12,500) * 0.15 = $18,075 Tax-savings onDepreciation = $18,075 * 0.35 Tax-savings onDepreciation = $6,326.25 Calculating Net OperatingCashflows :Year 1
Year 2
Year 3
After-tax Cost Savings $28,600.00 $28,600.00 $28,600.00 Tax-savings on Depreciation $13,917.75 $18,978.75 $6,326.25 Net Operating Cashflows $42,517.75 $47,578.75 $34,926.25Related Questions
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