Question

You must evaluate a proposal to buy a new milling machine. The base price is $120,000, and shipping and installation costs would add another $15,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $70,000. The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. The machine would require a S6,000 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $46,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine. ) What is the milling machine's terminal (non-operating) cash flow at the end of year 3?

A. $76,000
B. $54,440
C. $51,500
D. $54,808

Answer 1

Option (D) is correct.

Step-by-step explanation:

Cost = base price + shipping and installation costs

= $120,000 + $15,000

= $135,000

Depreciation Year 1 = 33% × 135000

= 44,550

Depreciation Year 2 = 45% × 135000

= 60,750

Depreciation Year 3 = 15% × 135000

= 20,250

Accumulated Depreciation on machine at the end of year 3 :

= Depreciation Year 1 + Depreciation Year 2 + Depreciation Year 3

= 44,550 + 60,750 + 20,250

= 125,550

Hence Book Value at the end of year 3 = $135,000 - $125,550

= $9,450

Sale Value = $70,000

Gain on sale of asset = $70000 - $9450

= $60550

Tax on gain on sale of asset = 35% × 60550

= $21,192.5

Hence, net cash flow from sale of asset = $70,000 - $21,192.5

= $48,807.5

Terminal Cash Flow:

= Net Cash flow from sale of asset + net working capital

= $48,807.5 + $6,000

= $54,807.5 or $54,808