A firm is considering replacing its computer system with a new one. The new syst
ID: 2737023 • Letter: A
Question
A firm is considering replacing its computer system with a new one. The new system is expected to have an annual operational cost savings of $49,175. The initial cost of the new system is $183,009 and it will last for six years. The 3-year MACRS depreciation method will be used on the new computer system. The current computer system has annual depreciation of $5,487. Both systems will be worthless in six years. The new system requires an initial investment of $3,302 in net working capital, which will be recovered at the end. The marginal tax rate is 0.34 and the annual required return is 0.13. What is the incremental cash flow of this replacement project in year six (the end of the project's life)? Answer format: Round to two decimal places. Do not use dollar sign or thousands separators.
Explanation / Answer
NOTE 1) Under 3-year MACRS depreciation method, Depreciation rates are 33.33 %, 44.45 %, 14.81 % and 7.41 % for first, second, third and fourth years respectively. Thus, it is clear that depreciation amount on new computer system is zero in sixth year as the asset will be fully depreciated over four years in 3-year MACRS depreciation method.(33.33 + 44.45 + 14.81 + 7.41 = 100 %)
NOTE 2) Depreciation on Current (Existing) Computer system will not be charged in Sixth year as Current Computer system is being replaced with the New Computer System.Thus, it lead to Savings in name of depreciation on current computer system amounting to $ 5487.
The incremental cash flow of this replacement project in year six:-
Annual Operational cost savings
(+) Savings in depreciation on Current Computer System (NOTE 2)
49175
5487
Total Savings in year six before tax
(-) Tax @ 34 %
54662.00
18585.08
Total Savings in year six after tax
(+) Salvage value of working capital
36076.92
3302.00
Conclusion:- The incremental cash flow of this replacement project in year six = $ 39378.92 (approx)
Annual Operational cost savings
(+) Savings in depreciation on Current Computer System (NOTE 2)
49175
5487
Total Savings in year six before tax
(-) Tax @ 34 %
54662.00
18585.08
Total Savings in year six after tax
(+) Salvage value of working capital
36076.92
3302.00
The incremental cash flow of this replacement project in year six 39378.92Related Questions
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