Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The origi
ID: 2771324 • Letter: M
Question
Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $36,000; it is now five years old, and it has a current market value of $15,500. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $18,000 and an annual depreciation expense of $3,600. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $25,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $4,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 34 percent tax rate.
What will the cash flows for this project be? (Note that the $36,000 cost of the old oven is depreciated over ten years at $3,600 per year. The half-year convention is not used for the old oven. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places.)
What will the cash flows for this project be? (Note that the $36,000 cost of the old oven is depreciated over ten years at $3,600 per year. The half-year convention is not used for the old oven. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places.)
Explanation / Answer
Calculation of Cash Flows: 0 1 2 3 4 5 6 Cost of New Oven 25,000 Less: Sale of Old Oven -15,500 Cash Outflow 9,500 Cash Inflow 4,000 4,000 4,000 4,000 4,000 4,000 Less: Depreciation 5,400 8,640 5,184 3,110.40 3,110.40 1,555.20 Cash Flow before Tax -1,400 -4,640 -1,184 890 890 2,445 Less: tax 0 0 0 302.464 302.464 831.232 Add: Depreciation 5,400 8,640 5,184 3,110.40 3,110.40 1555.2 Cash Inflow 4,000 4,000 4,000 3,698 3,698 3,169 DF(10%) 0.909 0.826 0.751 0.683 0.621 0.564 Discounted Cash Inflow 3,636.00 3,304.00 3,004.00 2,525.42 2,296.17 1,787.19
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