7. The management of Maverick Equipment Company is planning to purchase a new ex

Question

7. The management of Maverick Equipment Company is planning to purchase a new extruder that will cost $175,000 installed. The old machine has been fully depreciated, but can be sold for $18,000. The new machine will be depreciated on a straight line basis over its 10 year economic life to an estimated salvage of $10,000. If the machine will save Maverick $30,000 a year in production expenses, what are the annual net cash flows associated with the purchase of this machine? Assume a marginal tax rate of 40%.

Explanation / Answer

Solution:

Year 0 Year 1 to 9 Year 10 Purchase of Extruder 175,000 Less: Sale of old machine 18,000 Add: Tax expnese on gain on sale of old machine 7200 Cash outflow 164,200 Savings in production expense 30,000 30,000 Less: Incremental Depreciation - ( 175,000 - 10,000 /10 ) 16,500 16,500 Net savings before tax 13,500 13,500 Less: Tax expense - 40 % 5400 5400 Net savings after tax 8,100 8,100 Add: Terminal Value 10,000 Add: Depreciation 16,500 16,500 Net Annual Cash flows 24,600 34,600

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