Question

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $40,000 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $10,000. The grill will have no effect on revenues but will save Johnny’s $20,000 in energy expenses. The tax rate is 35%. (LO9-2) a. What are the operating cash flows in each year? b. What are the total cash flows in each year? c. If the discount rate is 12%, should the grill be purchased?

Answer 1

Answer: The answer is given below

Explanation:

For the question, the operating cash flows for each year is gotten by adding the depreciation tax rate to the net of the tax improvement in the operating income. The net of the tax improvement in the operating income.

= $20,000 × (1 - tax rate)

= $20,000 × (1 - 35%)

= $20,000 × (1 - 0.35)

= $20,000 × 0.65

= $13,000

a. The operating cash flows in each year has been attached.

b. The total cash flow will be the value of the operating cash flow added to the cash flow that are associated with investments. At year 0, initial investment was $40,000. After selling the grill at year 3, book value will be $2,964. Therefore, the sale price of the net tax will be:

=(Sales price - tax rate) × (sales price - book value)

=($10,000 - [35% × ($10,000 - $2,964)]

= $10,000 - [0.35 × $7036]

= $10,000 - $2,462.6

= $7,537.4

Total cash flow = $15073.4 + $7537.4

= $22,610.8

c. If the discount rate is 12%, this implies that the grill should be bought due to the fact that the net present value (NPV) of the cash flow is $7,191.8 which has a positive value.

The table has also been attached for further explanation.