A company wants to update their assets by buying some new machinery and selling
ID: 2794311 • Letter: A
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? $88,000 c) $185,000 $140,000 d) $215,000 12. What is the Depreciation Expense in year one? 18,000 c) 48,000 33,000 d) 81,000 13. What is the Operating Cash Flow in year two for this project? 13,000 c) 48,000 35,000 d) 76,000 14. What is the after tax salvage value of selling the new machinery in three years? 7,000 c) 11,200 8,800 d) 12,000
Explanation / Answer
11.
Net Investment for this project = Cost of new machinery + Sale Proceeds of the old machinery
Cost of the new machinery = $100,000
Sale Proceeds of old machinery = $10,000 +/- Tax Shield / Expense
Book Value of old machinery as on the date = $60,000 - ((60,000/4)*3)
= 60,000 - 45,000
= $15,000.
Recovery value from the sale of old machinery = $10,000
So, there is a capital loss of $5,000 (10,000 - 15,000)
Tax shield on such capital loss = $5,000 * 40%
= $2,000
So, net sale proceeds from the old machinery = $10,000 + Tax shield
= $10,000 + $2,000
= $12,000.
Net Investment = $100,000 - $12,000
= $88,000.
Hence the answer is $88,000.
12.
Depreciation Expense in year of the machinery * Rate of depreciation
= $100,000 * 33%
= $33,000.
Hence, the answer is $33,000.
13.
Operating Cash Flow in year two.
Hence, the answer is $138,000.
14.
After tax salvage value of selling the new machinery in three years
Salvage value recoverable at the end of 3 years = $10,000
Less: Book value of the machine at the end of 3 years = ($7,000)
Capital gains on the sale of machine = $3,000
Capital gains tax @ 40% (3,000 * 40%) = $1,200
Salvage value of the machine = $10,000
Less: Capital gains tax = ($1,200)
After tax salvage value of selling the new machine in 3years = $8,800.
Hence, the answer is $8,800.
Particulars Amount $ Sales 500,000 Less: COGS (500,000 * 60%) (300,000) Depreciaition (100,000 * 45%) (45,000) Earning Before Tax 155,000 Less: Tax @ 40% (155,000 * 45%) (62,000) Earnings After Tax 93,000 Add: Depreciation 45,000 Operating Cash Flow 138,000Related Questions
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