Question

Your company is considering expanding operations and buying a new machine to handle the increased volume. The machine's basic price is $100,000, and it will cost another $15,000 to modify it for special use by your firm. The machine falls into the MACRS three-year class, and it will be sold after three years for $15,000. Use of the machine will require an increase in net working capital (inventory) of $3,000. The machine will increase revenues by $50,000 per year, and is expected to increase annual costs by $5,000. The firm's marginal tax rate is 40 percent. MACRS3: Year 1 = .33; Year 2 = .45; Year 3 = .15; Year 4 = .07 What is the terminal (non-operating) cash flow at the end of Year 3?

Answer 1

Answer is $15,220

Initial Investment = Base Price + Modification Cost
Initial Investment = $100,000 + $15,000
Initial Investment = $115,000

Useful Life = 3 years

Depreciation Year 1 = 0.33 * $115,000
Depreciation Year 1 = $37,950

Depreciation Year 2 = 0.45 * $115,000
Depreciation Year 2 = $51,750

Depreciation Year 3 = 0.15 * $115,000
Depreciation Year 3 = $17,250

Book Value at the end of Year 3 = $115,000 - $37,950 - $51,750 - $17,250
Book Value at the end of Year 3 = $8,050

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $15,000 - ($15,000 - $8,050) * 0.40
After-tax Salvage Value = $12,220

Initial Investment in NWC = $3,000

Year 3:

Terminal Cash Flows = NWC recovered + After-tax Salvage Value
Terminal Cash Flows = $3,000 + $12,220
Terminal Cash Flows = $15,220