Question

Terminal cash flow—Various lives and sale prices Looner Industries is currently analyzing the purchase of a new machine that costs $160,000 and requires $20,000 in installation costs. Purchase of this machine is expected to result in an increase in net working capital of $30,000 to support the expanded level of operations. The firm plans to depreciate the machine under MACRS using a 5-year recovery period (see the table for the applicable depreciation percentages) and expects to sell the machine to net $10,000 before taxes at the end of its usable life. The firm is subject to a 40% tax rate. a. Calculate the terminal cash flow for a usable life of (1) 3 years, (2) 5 years, and (3) 7 years. b. Discuss the effect of usable life on terminal cash flows using your findings in part a. C. Assuming a 5-year usable life, calculate the terminal cash flow if the machine were sold to net (1) $9,000 or (2) $170,000 (before taxes) at the end of 5 years. d. Discuss the effect of sale price on terminal cash flow using your findings in part c. a. Calculate the terminal cash flow for a usable life of (1) 3 years, (2) 5 years, and (3) 7 years. The following table can be used to solve for the terminal cash flow: (Round to the nearest dollar.) 3-year Proceeds from sale of proposed asset +/- Tax on sale of proposed asset Total after-tax proceeds-new + Change in net working capital Terminal cash flow Enter any number in the edit fields and then click Check Answer

Answer 1

Cost of new machine: $160,000

Installation cost: $20,000

Net working capital: +30,000

5 year MACRS

Selling price of machine: $10,000

Tax rate: %40

3 Year =

BV: 180,000 –(180,000 x %71) =$52,200

10,000 –52,200 = -42,200 loss

42,200 x 0.40 = 16,880 tax benefit

5 Year

BV: 180,000 –(180,000 x %95)

= $9,000

10,000 –9,000 = 1,000 gain

1,000 x 0.40 = 400

7 Year

BV = 180,000 –(180,000 x %100) = $0

10,000 –0 = 10,000

10,000 x 0.40 = $4,000

	3 Year	5 Year	7 Year
Proceeds from sale of new machine	10000	10000	10000
Tax on sale of new machine	16880	-400	-4000
After tax proceed	26880	9600	6000
Changing NWC	30000	30000	30000
Terminal cash flow	56880	39600	36000