Question

A company is analyzing the replacement of a color copier. The old machine was purchased 3 years ago for $30,000; it falls into the MACRS 5-year class; and it has 2 years of remaining life and an $8,000 salvage value 2 years from now. The current market value of the old machine is $17,000. The new machine has a price of $40,000, plus an additional $2,000 for installation and modification and an additional $2,000 for transportation. The new machine falls into the MACRS 5-year class, has a 2-year economic life, and can be salvaged for $23,000. The new machine will require a $7,000 increase in inventory, and accounts payable is expected to increase by $4,000. The new machine is expected to increase revenue by $8,000 per year and decrease costs by $3,000 per year. The firm has an 11 percent cost of capital and a marginal tax rate of 25 percent. The MACRS 5-year class uses the following percentages: 20%, 32%, 19%, 12%, 11%, and 6% (in that order). (Round all CFs to the nearest dollar.) What is the total net cash outflow at Year 0

Answer 1

Answer:

E. Outflow of $32,075

Explanation:

At Year 0, the cash outflow is calculated as under:

Year 1 Outflow = Investment in the New asset (Step1) + Net working capital required  (Step2) - Sale Proceeds from the old machine  (Step3) -  Tax On the sale of old Machinery  (Step4)

Year 1 Outflow = $44,000 + $3,000 - $17,000 + $2,075 = $32,075

Step 1:  Investment in the New asset

Now here:

Investment in the New Asset = New machine cost + Transportation of asset + Installation of asset

By putting values, we have:

Investment in the New Asset = 40000 + 2000 + 2000 = $44,000

Step 2: Net working capital required

Now

Net working capital required = $7,000 Investment in Inventory - $4,000 Increase in payables = $3,000

Step 3: Sale Proceeds from the old machine

Fair Value of the Old Machine is $17000 which means this would be the sales proceeds on the old machinery's sales.

Step 4: Tax On the sale of old Machinery

Old machine purchased 3 year ago at = $30,000

Depreciation schedule and book value of old machine are as follows:

Year            1             2           3           4           5           6

MACRS Rate   20%       32%      19%       12%       11%           6%

Depreciation  6000     9600    5700    3600     3300      1800

Acc. depre.     6000    15600   21300   24900  28200    30000

Book value    24000   14400    8700     5100     1800          0

Now

From the table we can see that the Book value of the asset at the end of the year 3 is $8,700.

Tax on the gain of the asset = ($17,000 - 8,700) * 25% = $2,075