RHPS company is considering the purchase of a new machine to replace an existing

Question

RHPS company is considering the purchase of a new machine to replace an existing machine. The old machine was purchased 5 years ago at a cost of $50, 000, and was being depreciated to a salvage value of 0 over 10 years using straight line depreciation. The current market value of the old machine is $20, 000. The new machine falls into the MACRS 5-year class, has an estimated life of 5 years, it costs $100, 000 and RHPS plans to sell the machine at the end of the fifth year for $10, 000. The new machine is expected to generate new sales of $30, 000 per year and will increase costs an extra $5, 000 per year as well. In addition, the company will need to increase inventory by $5, 000 and increase account receivable by $5, 000 as well, The company's tax rate is 40 percent. (Numbers in parenthesis are negative)

(1) What would be the cash flow from assets (CFFA) at t=0?
a. ($90, 000)
b. ($78, 000)
c. ($92, 000)
d. ($88, 000)
e. ($80, 000)

(2) What would be the cash flow from assets (CFFA) at t=1?
a. $21, 000.00
b. $23, 000.00
c. $29, 000.00
d. $26, 332.00
e. $15, 000.00

(3) What would be the book value of the new machine in year 4, t=4?
a. $80, 000
b. $48, 000
c. $28, 800
d. $17, 280
e. $5, 760

Explanation / Answer

(1) AT T=0, Year 0 Accum Dep on Old Machine = 5*(50000/10) = 25000 Sale value of Old Machne = 20000 Cash Flow From Assets (CFFA) = OCF – net capital spending (NCS) – changes in NWC Cost of new machine = 100,000 (outflow) After-tax salvage on old machine = 20,000 - .4(20,000 – 25,000) = 22,000 (inflow) Incremental net capital spending (NCS) = 100,000 – 22,000 = 78,000 (outflow) Change in NWC = increase inventory by $5, 000 and increase account receivable by $5, 000 = 5000+5000 = 10,000 So Cash Flow From Assets (CFFA) = 0 - 78000-10000 = -88000 .......Ans (1d) (2). As per 5 Yrs MCARS Table, Dep in Y1 = 20%. So Dep in Y1 = 20%*100,000 = 20000 EBIT = Sales - Addl Cost- Dep = 30000-5000 -20000 = 5000 OCF = EBIT – Taxes + Depreciation = 5000 - 0.40*(5000) + 20000 = 23,000 ..Ans (2b) (3) Dep rate under MCARS for Y1 = 0.20, Y2 is 0.32, Y3=0.192, Y4=0.115. So CUmulative MCARS for 4 Yrs = 0.20+0.32+0.192+0.1152 = 0.8272 So Accum Dep in Y4 = 0.8272*100,000= $82720 So BV = 100,000 - Accum Dep = 100,000- $82720 = 17280 ......Ans (3d)

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