Question

6) (28 points) A company is considering a replacement for an aging machine that has been fully depreciated for tax purposes. The new machine will have an initial cost of $400,000 and is expected to generate an income of $125,000 per year. Its estimated salvage value at the end of its useful life of 4 years will be $60,000. The new machine is a MACRS-GDS 3-year property for calculating depreciation deductions. The effective tax rate is 35%. a) (20 points) For this new machine, determine the after-tax cash flow for each year of operation. (Round off values to the nearest dollar) EOY BTCF MACRS-GDS Taxable Tax ATCF Deduction Income 0 1 2 3 4 b) (8 points) If the after-tax MARR is 10% per year compounded annually, compute the PW of the after-tax cash flows. Based on this PW, would you recommend the purchase of this new machine?

Answer 1

Tax rate = 35%

Depreciation = Purchase value * Depreciation rate

Taxable income = BTCF - Depreciation

Tax = Tax rate * Taxable income

ATCF = Taxable income - Tax + Depreciation

Salvage value at end of EOY 4 will be depreciation recapture so it will be taxable

a.

using Excel

Year	BTCF	MACRS Factor	Depreciation	Taxable income	Tax	ATCF
0	-400000.00					-400000.00
1	125000.00	0.3333	133320.00	-8320.00	-2912.00	127912.00
2	125000.00	0.4445	177800.00	-52800.00	-18480.00	143480.00
3	125000.00	0.1481	59240.00	65760.00	23016.00	101984.00
4	185000.00	0.0741	29640.00	155360.00	54376.00	130624.00
					NPW	702.19

b.

NPW = 702.19

As NPW is positive, machine should be purchased

Showing formula in excel

Year	BTCF	MACRS Factor	Depreciation	Taxable income	Tax	ATCF
0	-400000					=B62
1	125000	0.3333	=C63*-B$62	=B63-D63	=E63*0.35	=B63-F63
2	125000	0.4445	=C64*-B$62	=B64-D64	=E64*0.35	=B64-F64
3	125000	0.1481	=C65*-B$62	=B65-D65	=E65*0.35	=B65-F65
4	=60000+125000	0.0741	=C66*-B$62	=B66-D66	=E66*0.35	=B66-F66
					NPW	=NPV(10%,G63:G66)+G62