A company wants to update their assets by buying some new machinery and selling some old equipment. The new machinery will cost $100,000 and will be depreciated using 3-year MACRS (33%, 45%, 15%, 7%). At the end of the third year, the machinery is expected to be sold for $10,000. The old equipment was bought three years ago for $60,000 and was being depreciated over four years using straight-line depreciation. It can be sold today for $10,000. If they do not buy the new machinery and replace the old equipment, then the old equipment is expected to be held for another three years at which point it will be worthless. Regardless of whether they buy the new machinery, Sales will be $500,000 for the next three years, but COGS will fall from 70% of Sales to 60% of Sales if they buy the new machinery. The tax rate is 40%.
Balance Sheet Effects ......|-----------Depreciation Expenses------------|
Today ---------------------------Year 1 Year 2 Year 3 --------------------------End
1. Buy New Assets
2. Sell Old Assets
Income Statement Effects... Year 1 Year 2 Year 3
Net Sales
-Net COGS
-Net Depreciation
= Net OEBT
- Net Taxes
= Net OEAT
+ Net Depreciation
= Net Operating CF
11. What is the Net Investment (Initial Cash Outflow or CF0) for this project?
12. What is the Depreciation Expense in year one?
13. What is the Operating Cash Flow in year two for this project?
14. What is the after tax salvage value of selling the new machinery in three years?
A company wants to update their assets by buying some new machinery and selling some old equipment. The new machinery will cost $100,000 and will be depreciated using 3-year MACRS (33%, 45%, 15%, 7%). At the end of the third year, the machinery is expected to be sold for $10,000. The old equipment was bought three years ago for $60,000 and was being depreciated over four years using straight-line depreciation. It can be sold today for $10,000. If they do not buy the new machinery and replace the old equipment, then the old equipment is expected to be held for another three years at which point it will be worthless. Regardless of whether they buy the new machinery, Sales will be $500,000 for the next three years, but COGS will fall from 70% of Sales to 60% of Sales if they buy the new machinery. The tax rate is 40%.
Balance Sheet Effects ......|-----------Depreciation Expenses------------|
Today ---------------------------Year 1 Year 2 Year 3 --------------------------End
1. Buy New Assets
2. Sell Old Assets
Income Statement Effects... Year 1 Year 2 Year 3
Net Sales
-Net COGS
-Net Depreciation
= Net OEBT
- Net Taxes
= Net OEAT
+ Net Depreciation
= Net Operating CF
11. What is the Net Investment (Initial Cash Outflow or CF0) for this project?
12. What is the Depreciation Expense in year one?
13. What is the Operating Cash Flow in year two for this project?
14. What is the after tax salvage value of selling the new machinery in three years?
Related questions
Suppose you are thinking to replace an old machine with a new one for your business. The old
machine cost you $100,000, and the new one costs $150,000. The new machine will be
depreciated on a three-year MACRS basis. The new machine has a 5-year life and a salvage
value of zero at the end of this period. The old machine was purchased 5 years ago, and it is being depreciated at the rate of $9,000 per
year. Its book value is $55,000, and its salvage value today is $65,000. You estimate that you
will be able to sell the old machine for $10,000 in 5 years, if you decide to not replace it.
The new machine will save you $50,000 per year. The tax rate is 40%, and the required rate of
return is 10%. Based on the NPV and IRR investment criteria, should you replace the old
machine? Should the cost of the old machine be included in your decision? Why or why
not? Calculate the Initial Investment of the project, and the Terminal Cash Flow of the
project.
This was the Excel format that we were given:
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | ||
| Cost Savings | $50,000 | $50,000 | $50,000 | $50,000 | $50,000 | |
| Depreciation New | ||||||
| Depreciation Old | $9,000 | $9,000 | $9,000 | $9,000 | $9,000 | |
| Increm | ||||||
| EBIT | ||||||
| Taxes | ||||||
| NI | ||||||
| Year | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year5 |
| OCF | ||||||
| NCS | ||||||
| Change in NWC | ||||||
| CCFA | ||||||
| NPV | ||||||
| IRR | ||||||
