Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The origi
ID: 3143202 • Letter: M
Question
Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $48,000; it is now five years old, and it has a current market value of $22,500. 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 $24,000 and an annual depreciation expense of $4,800. 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 $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $2,800 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 30 percent tax rate.
What will the cash flows for this project be?(Note that the $48,000 cost of the old oven is depreciated over ten years at $4,800 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.)
Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $48,000; it is now five years old, and it has a current market value of $22,500. 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 $24,000 and an annual depreciation expense of $4,800. 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 $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $2,800 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 30 percent tax rate.
Explanation / Answer
Free cash flow in year 0 = - Initial investment in new oven+ salvage value of the old oven - tax on salvage value
Initial investment in new oven = 27,000.
Salvage value of current oven = 22,500. Tax on salvage value = 30% of 22,500 = $6,750
Thus free cash flow in year 0 = -27,000+22,500-6,750 = -11,250
Depreciation for the new oven using 5 year MACRS rate:
Thus FCF in years 1 to 6 = before tax cash savings from the new oven - tax (@30%) + depreciation on new oven - depreciation of old oven
Cost Rate (%) Year Depreciation amount 27,000.00 20.00 1 5,400.00 32.00 2 8,640.00 19.20 3 5,184.00 11.52 4 3,110.40 11.52 5 3,110.40 5.76 6 1,555.20Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.