A company wants to update their assets by buying some new machinery and selling

Question

A company wants to update their assets by buying some new machinery and selling some old equipment. The new machinery will cost $100,000 and will be depreciated using 3-year MACRS (33%, 45%, 15%, 7%). At the end of the third year, the machinery is expected to be sold for $10,000. The old equipment was bought three years ago for $60,000 and was being depreciated over four years using straight-line depreciation. It can be sold today for $10,000. If they do not buy the new machinery and replace the old equipment, then the old equipment is expected to be held for another three years at which point it will be worthless. Regardless of whether they buy the new machinery, Sales will be $500,000 for the next three years, but COGS will fall from 70% of Sales to 60% of Sales if they buy the new machinery. The tax rate is 40%.

Balance Sheet Effects ......|-----------Depreciation Expenses------------|

Today ---------------------------Year 1 Year 2 Year 3 --------------------------End

1. Buy New Assets

2. Sell Old Assets

Income Statement Effects... Year 1 Year 2 Year 3

Net Sales

-Net COGS

-Net Depreciation

= Net OEBT

- Net Taxes

= Net OEAT

+ Net Depreciation

= Net Operating CF

11. What is the Net Investment (Initial Cash Outflow or CF0) for this project?

12. What is the Depreciation Expense in year one?

13. What is the Operating Cash Flow in year two for this project?

14. What is the after tax salvage value of selling the new machinery in three years?

Explanation / Answer

11. Net Investment:

Sale of old equipment $10,000. This machine was bought four years ago and depriciated at straight line method. hence the depriciation each year is 60000/4 = $15,000

For three years, the depricated value is 45,000 and the book value is 15,000. Since book value is more than actual sale value, there is no taxes.

hence the net investment is 100000-10000 =$90,000

12. Depricaition expense for year one.

Since the equipment is depricated at 33% for year one as per the MACRS depriciation, the expense is 100000*0.33 = $33,000 for year 2

13. Operating Cash flow for year 2 is as shown below:

14. After ATx salvage value of new machine

Book value of the machine at the end of the thord year is 7% = 7%*100000 =7000

Sale value of 10,000

Tax = 40% of( Sale value - Book Value ) = 0.4 *(10000-7000) = 12000

Hence After tax salvage value is 10000-1200 = $8,800

Sales 500000 COGS 60% of sales assuming they purchase new machine 300000 Deprication for year 2 at 45% 45000 Net before Tax (OEBT) 155000 Taxes at 40% 62000 OAET (After tax) 93000 Add: Deprication 45000 Operating Cash flow for year 2 138000

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.