From the question we can gather the following information:
Purchase Cost of New Machine | $ 155,000 |
Installation Cost | $ 19,700 |
Increase in Net Working Capital | $ 29,600 |
Expected Proceed Received from Disposal | $ 10,400 |
Tax Rate | 40% |
From the above table we can calculate:
Total Cost of the new Machine = Purchase Cost of New Machine + Installation Cost
= $155,000 + $19,700
= $174,700
a) Here we have to calculate the terminal cash flow for useful life.
Option-(1)
Useful Life = 3 Years
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
Depreciation Value | |||
Year-1 | Year-2 | Year-3 | |
3 years useful life | $ 34,940 | $ 55,904 | $ 33,193 |
Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% |
So,
Salvage value of the machine = Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193)
= $174,700 - $124,037
= $50,663
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $10,400 - $50,663
= ($40,263)
Now, we will calculate the Terminal Cash flow for useful life of 3 years:
Legend | Formula | 3 Years | |
Proceeds from Sale of proposed Asset | R | $ (40,263) | |
+/- Tax on Sale of proposed Asset | T | =R*40% | $ 16,105 |
Total after Tax proceeds | S | =R+T | $ (24,158) |
+ Change in Working Capital | NWC | $ 29,600 | |
Terminal Cash Flow | CF | =S+NWC | $ 5,442 |
Option-(2)
Useful Life = 5 Years
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |
5 years useful life | $ 34,940 | $ 55,904 | $ 33,193 | $ 20,964 | $ 20,964 |
Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% | =$174,700*12% | =$174,700*12% |
So,
Salvage value of the machine
= Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193 + $20,964 + $20,964)
= $174,700 - $165,965
= $8,735
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $10,400 - $8,735
= $1,665
Now, we will calculate the Terminal Cash flow for useful life of 5 years:
Legend | Formula | 5 years | |
Proceeds from Sale of proposed Asset | R | $ 1,665 | |
+/- Tax on Sale of proposed Asset | T | =R*40% | $ (666) |
Total after Tax proceeds | S | =R+T | $ 999 |
+ Change in Working Capital | NWC | $ 29,600 | |
Terminal Cash Flow | CF | =S+NWC | $ 30,599 |
Option-(3)
Useful Life = 7 Years
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
Depreciation Value | |||||||
Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Year-6 | Year-7 | |
7 years useful life | $ 34,940 | $ 55,904 | $ 33,193 | $ 20,964 | $ 20,964 | $ 8,735 | $ - |
Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% | =$174,700*12% | =$174,700*12% | =$174,700*5% |
So,
Salvage value of the machine
= Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193 + $20,964 + $20,964 + $8,735)
= $174,700 - $174,700
= $0
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $10,400 - $0
= $10,400
Now, we will calculate the Terminal Cash flow for useful life of 7 years:
Legend | Formula | 7 years | |
Proceeds from Sale of proposed Asset | R | $ 10,400 | |
+/- Tax on Sale of proposed Asset | T | =R*40% | $ (4,160) |
Total after Tax proceeds | S | =R+T | $ 6,240 |
+ Change in Working Capital | NWC | $ 29,600 | |
Terminal Cash Flow | CF | =S+NWC | $ 35,840 |
b) From the finding in part (a) we can get the below mentioned information:
Useful Life | |||||
Legend | Formula | 3 Years | 5 years | 7 years | |
Total Cost of a New Machine | C | $ 174,700 | $ 174,700 | $ 174,700 | |
Total Depreciation | D | $ 124,037 | $ 165,965 | $ 174,700 | |
Salvage Value | SV | =C-D | $ 50,663 | $ 8,735 | $ - |
Expected Proceed Received from Disposal | P | $ 10,400 | $ 10,400 | $ 10,400 | |
Proceeds from Sale of proposed Asset | R | =P-SV | $ (40,263) | $ 1,665 | $ 10,400 |
+/- Tax on Sale of proposed Asset | T | =R*40% | $ 16,105 | $ (666) | $ (4,160) |
Total after Tax proceeds | S | =R+T | $ (24,158) | $ 999 | $ 6,240 |
+ Change in Working Capital | NWC | $ 29,600 | $ 29,600 | $ 29,600 | |
Terminal Cash Flow | CF | =S+NWC | $ 5,442 | $ 30,599 | $ 35,840 |
From the above table we can get the following observations:
So, we can see that, with increase in usable life the Terminal Cash Flow will increase.
c) Here we will calculate the Terminal Cash Floe of the machine considering 5 years usable life and different Disposal value.
Option-(1)
Useful Life = $8,735 (before Taxes)
Now we will calculate the depreciation value of the machine under MACRS using 5 Years recovery period. The calculation is given in the table below:
Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |
5 years useful life | $ 34,940 | $ 55,904 | $ 33,193 | $ 20,964 | $ 20,964 |
Formula | =$174,700*20% | =$174,700*32% | =$174,700*19% | =$174,700*12% | =$174,700*12% |
So,
Salvage value of the machine
= Total Cost of the new Machine - Total Depreciation
= $174,700 - ($34,940 + $55,904 + $33,193 + $20,964 + $20,964)
= $174,700 - $165,965
= $8,735
Hence, Proceeds from Sale of proposed Asset (R)
= Expected Proceed Received from Disposal - Salvage value of the machine
= $8,735 - $8,735
= $0
Now, we will calculate the Terminal Cash flow for useful life of 5 years:
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