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 $6,000 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 total year 3 cash flow (year 3 operating cash flow year 3 terminal cash flow) for the proposed milling machine

Answer 1

$91,795

Step-by-step explanation:

The computation of the total year 3 cash flow is shown below:

Total year 3 cash flow = After tax saving in labor cost + depreciation expense × tax rate + working capital recovery + after tax salvage value

where,

After tax salvage value is

= Sale value - tax on capital gain

= $70,000 - {($70,000 - $135,000 × 7%) × 35%}

= $48,807.50

Now total year 3 cash flow is

= $46,000 × 0.65 + ($135,000 × 15%) × 0.35 + $6,000 + $48,807.50

= $91,795

The $135,.000 is come from

= $120,000 + $15,000

We simply applied the above formula