Question

Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $48,000; it is now five years old, and it has a current market value of $22,500. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $24,000 and an annual depreciation expense of $4,800. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $2,800 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 30 percent tax rate. What will the cash flows for this project be?

Answer 1

Cash flows are as follows

Year	Initial cash flow	Salvage of old machine	After tax saving	Tax saving on depreciation	Cash Flows
0	-27000	-22950			-49950
1			$840.00	1620	2460
2			$840.00	2592	3432
3			$840.00	1555.2	2395.2
4			$840.00	933.12	1773.12
5			$840.00	933.12	1773.12
6			$840.00	466.56	1306.56

Salvage of old machine
Purchase price	48000
Less: Depreciation	24000
Closing book value	24000
Selling price	22500
Gain/(loss)	-1500
Less Tax	-450
After tax salvage	22950

WORKINGS