Question

Consider the case of Marston Manufacturing Company: Marston Manufacturing Company is considering a project that requires an investment in new equipment of $3,570,000. Under the new tax law, the equipment is eligible for 100% bonus depreciation at t = 0 so the equipment will be fully depreciated at the time of purchase. Marston estimates that its accounts receivable and inventories need to increase by $680,000 to support the new project, some of which is financed by a $272,000 increase in spontaneous liabilities (accounts payable and accruals). The company's tax rate is 25%. The after-tax cost of Marston's new equipment is Marston's initial net investment outlay is $680,000 $2,677,500 Suppose Marston's new equipment is expected to poo at the end of its four-year useful life, and at the same time, the firm expects to $3,400,000 recover all of its net operating working capital (NC procent. Remember, that under the new tax law, this equipment was fully depreciated at t

Answer 1

After tax cost of Equipment = Purchase cost – Tax savings on Depreciation

= 3,570,000 – 3,570,000*25%

= $2,677,500

Initial Outlay = Cost of Equipment + Increase in current assets – Increase in current liabilities

= 2,677,500 + 680,000-272000

= $3,085,500

Termination Cash flows:

After tax salvage value = (400,000-0)*(1-25%) = $300,000

Recovery of Working Capital = $408,000

Termination Value = $708,000