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 BTCE MACRS-GDS Taxable Tax ATCE Deduction Income 0 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

1. Calculation of BTCF (Before tax cash flows)

EOY	Revenue	Salvage Value	Total Inflow
N	A	C	D=A+C
-	-	-	-
1	1,25,000	-	1,25,000
2	1,25,000	-	1,25,000
3	1,25,000	-	1,25,000
4	1,25,000	60,000	1,85,000

2. Depreciation Schedule

Cost of Asset	4,00,000
Year	Rate	Depreciation
Year 1	33.33%	1,33,320
Year 2	44.45%	1,77,800
Year 3	14.81%	59,240
Year 4	7.41%	29,640

3. Final Schedule

EOY	BT & LCF	MACRS Depreciation	Taxable Income	Tax	ATCF
N	A	D	E=A-D	F=E*35%	G=E-F+D
-	-4,00,000			-	-4,00,000	Capital Investment
1	1,25,000	1,33,320	-8,320	-2,912	1,27,912
2	1,25,000	1,77,800	-52,800	-18,480	1,43,480
3	1,25,000	59,240	65,760	23,016	1,01,984
4	1,85,000	29,640	1,55,360	54,376	1,30,624

4. Using MARR of 10%, PW of cash flows

EOY	BT & LCF	MACRS Depreciation	Taxable Income	Tax	ATCF	MARR	PW
N	A	D	E=A-D	F=E*35%	G=E-F+D	H=1/1.1^N	I=H*G
-	-4,00,000			-	-4,00,000	1.000	-4,00,000
1	1,25,000	1,33,320	-8,320	-2,912	1,27,912	0.893	1,14,207
2	1,25,000	1,77,800	-52,800	-18,480	1,43,480	0.797	1,14,381
3	1,25,000	59,240	65,760	23,016	1,01,984	0.712	72,590
4	1,85,000	29,640	1,55,360	54,376	1,30,624	0.636	83,014
						NPV (Sum of I)	-15,807

As NPV is negative, it is not recommended to invest.

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