Question

Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $40,000; it is now five years old, and it has a current market value of $17,500. 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 $20,000 and an annual depreciation expense of $4,000. 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 $26,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $4,100 a year over its life, you can use bonus depreciation on the oven, and the cost of capital is 10 percent. Assume a 21 percent tax rate. What will the cash flows for this project be? (Note that the $40,000 cost of the old oven is depreciated over ten years at $4,000 per year. The half-year convention is not used for the old oven. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places.)

Year	0	1	2	3	4	5	6
FCF

Answer 1

FCF = Cash from Operations – Capex

Cash from Operations = Net Income + Non Cash items adjustment – Increase in Working Capital

Initial Outlay = Fixed Capital Investment +Working Capital – Salvage Value + (Salvage Value – BookValue) * (Tax Rate)

Fixed Capital Investment ( New Oven ) = $26000

Working Capital = 0 (As no Data is given about it)

Salvage Value (Old oven) = $17500

Book Value(Old Oven) = $20000

Therefore Initial Outlay = 26K – 17.5K + (17.5K-20K)*21% = $7975

Therefore FCF for Year 0 = -$7975

Income Statement for 6 years:

Year	1	2	3	4	5	6
Total Gains	4100	4100	4100	4100	4100	4100
(-)Depreciation	26000	0	0	0	0	0
(-)Carry Over Loss	0	21900	17800	13700	9600	5500
IBT	-21900	-17800	-13700	-9600	-5500	-1400
(-)Tax(@21%)	0	0	0	0	0	0
Net Income	-21900	-17800	-13700	-9600	-5500	-1400

Non Cash Adjustment

This includes Depreciation and Carry Over Loss in this case

Non Cash Adjustments:
Year	1	2	3	4	5	6
Depreciation	26000	0	0	0	0	0
Carry Over Loss	0	21900	17800	13700	9600	5500
Total	26000	21900	17800	13700	9600	5500

Capex = 0

Change in Working Capital 0

Therefore

Year	1	2	3	4	5	6
Net Income	-21900	-17800	-13700	-9600	-5500	-1400
(+)Non Cash Adjustment	26000	21900	17800	13700	9600	5500
(-)Increase in Working Capital	0	0	0	0	0	0
Cash from Operations:	4100	4100	4100	4100	4100	4100

Capex = 0

Hence FCF = Initial Outlay + Cash from Operations

Year	0	1	2	3	4	5	6
FCF	-$7,975	$4,100	$4,100	$4,100	$4,100	$4,100	$4,100