Question

Attempts: Keep the Highest: 13 2. Incremental costs - Initial and terminal cash flow Consider the case of Alexander Industries: Alexander Industries is considering a project that requires an investment in new equipment of $3,360,000. Under the new tax law, the equipment is eligible for 100% bonus depreciation at t = 0 so the equipment will be fully depreciated at the time of purchase. Alexander estimates that its accounts receivable and inventories need to increase by $640,000 to support the new project, some of which is financed by a $256,000 increase in spontaneous liabilities (accounts payable and accruals). The company's tax rate is 25%. The after-tax cost of Alexander's new equipment is Alexander's initial net investment outlay is Suppose Alexander's new equipment is expected to sell for $200,000 at the end of its four-year useful life, and at the same time, the firm expects to recover all of its net operating working capital (NOWC) investment. Remember, that under the new tax law, this equipment was fully depreciated at t = 0. If the firm's tax rate is 25%, what is the project's total termination cash flow? O $200,000 O $434,000 $534,000 O $150,000 Grade It Now Save & Continue Continue without saving

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

B Tax rate 25% New Equipment Cost Bonus Depreciation at t=0 Tax shield of Depreciation $3,360,000.00 $3,360,000.00 $840,000.00 8 1 after-tax cost of Alexander's new equipment $2,520,000.00 Current Assets (receivables, inventory) increases by Current liabilities (accounts payable etc) increases by $640,000.00 $256,000.00 Increase in Net operating working capital $384,000.00 2 Alexander's Initial net investment outlay $2,904,000.00 Before tax salvage value of equipment After tax salvage value of equipment Recovery of NOWC $200,000.00 $150,000.00 $384,000.00 3 Project's Total termination cash flow $534,000.00 24

Cell reference -

в Tax rate 0.25 3360000 New Equipment Cost Bonus Depreciation at t=0 Tax shield of Depreciation =C4 =C5*C2 after-tax cost of Alexander's new equipment =C4-C6 Current Assets (receivables,inventory) increases by 640000 Current liabilities (accounts payable etc) increases by 256000 Increase in Net operating working capital =C10-C11 14 15 2 Alexander's Initial net investment outlay =C8+C13 18 Before tax salvage value of equipment After tax salvage value of equipment Recovery of NOWC 200000 =C18*(1-C2) =C13 20 Project's Total termination cash flow =C19+C20 22 3 23 24

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