A firm is considering the acquisition of a new machine. The base price is $85,00

Question

A firm is considering the acquisition of a new machine. The base price is $85,000 and it would cost $15,000 to install. The machine is MACRS 3 year class property and it will be sold after 3 years for $17,000. The machine would also require an increase in net working capital of $10,000. The machine is expected to increase before tax revenues by $40,000 per year. This firm is in a 34% marginal tax bracket. MACRS 3 year factors are 33%, 45%, 15%, and 7% for years 1 through 4 respectively. What is the terminal cash flow at the end of year 3.

Explanation / Answer

Depriciation under MACRS 1st year = 100000 * 33% = 33000 2nd year = 100000 * 45% = 45000 3rd year = 100000 * 15% = 15000 Hence total depriciation = 33000 + 45000 + 15000 = 93000 Hence book value at end of 3 years = Cost - Depriciation = 100000 - 93000 = 7000 Tax on disposal =( Proceeds - Book value ) * Tax rate = ( 17000 - 7000) * 34%                                   = 10000 * 34%                                   = 3400 After tax proceeds = Proceeds - Tax                                         = 17000 -3400 = 13600 Terminal Cash Flow = After tax proceeds from disposal + working capital recouped = 13600 + 10000 = 23600 Hence option D = 23600 is correct

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