Terminal cash flowlong dash—Replacement decisionRussell Industries is considerin
ID: 2794894 • Letter: T
Question
Terminal cash
flowlong dash—Replacement
decisionRussell Industries is considering replacing a fully depreciated machine that has a remaining useful life of 10 years with a newer, more sophisticated machine. The new machine will cost
$194,000
and will require
$29,900
in installation costs. It will be depreciated under MACRS using a 5-year recovery period (see the table
LOADING...
for the applicable depreciation percentages). A $21,000 increase in net working capital will be required to support the new machine. The firm's managers plan to evaluate the potential replacement over a 4-year period. They estimate that the old machine could be sold at the end of 4 years to net
$15,100 before taxes; the new machine at the end of 4 years will be worth $74,000 before taxes. Calculate the terminal cash flow at the end of year 4 that is relevant to the proposed purchase of the new machine. The firm is subject to a 40% tax rate.
The terminal cash flow for the replacement decision is shown below: (Round to the nearest dollar.)
Proceeds from sale of new machine $
Tax on sale of new machine
Total after-tax proceeds- new asset $
Proceeds from sale of old machine $
Tax on sale of old machine
Total after- tax proceeds old asset $
Change in net working capital $
Terminal cash flow $
(Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.)
Rounded Depreciation Percentages by Recovery Year Using MACRS for
First Four Property Classes
Percentage by recovery year*
Recovery year
3 years
5 years
7 years
10 years
1
33%
20%
14%
10%
2
45%
32%
25%
18%
3
15%
19%
18%
14%
4
7%
12%
12%
12%
5
12%
9%
9%
6
5%
9%
8%
7
9%
7%
8
4%
6%
9
6%
10
6%
11
4%
Totals
100%
100%
100%
100%
*These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year convention.
Rounded Depreciation Percentages by Recovery Year Using MACRS for
First Four Property Classes
Copy to Clipboard + Open in Excel +Percentage by recovery year*
Recovery year
3 years
5 years
7 years
10 years
1
33%
20%
14%
10%
2
45%
32%
25%
18%
3
15%
19%
18%
14%
4
7%
12%
12%
12%
5
12%
9%
9%
6
5%
9%
8%
7
9%
7%
8
4%
6%
9
6%
10
6%
11
4%
Totals
100%
100%
100%
100%
*These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year convention.
Explanation / Answer
new machine cost = 194000 + 29900 = 223900
Intial investment = 223900+ 21000 = 244900
terminal cashflow = 74000 - 74000*40% + 15100 - 15100*40% + 21000 = 74460
Depreciation in year 1 = 20%* 223900 = 44780
Tax shield = 40%*44780 = 17912
Depreciation in year 2 = 32%* 223900 = 71648
Tax shield = 40%*71648= 28659.20
Depreciation in year 3 = 19%* 223900 = 42541.00
Tax shield = 40%*42541 = 17016.40
Depreciation in year 4 = 12%* 223900 = 26868
Tax shield = 40%*26868 = 10747.20
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