Question

You have been asked by the president of your company to evaluate the proposed acquisition of a new special purpose truck for $50000. The truck falls into the MACRS 3 year class,and it will be sold after three years for $19400. Use of the truck will require an increase in NWC (spare parts inventory) of $1400. The truck will have no effect on revenues but it is expected to save the firm $17100 per year in before tax operating costs,mainly labor. The firms marginal tax rate is 34 percent. What will the cash flows for this project be?

Answer 1

Initial Investment = $50,000
Useful Life = 3 years

Depreciation Year 1 = 33.33% * $50,000
Depreciation Year 1 = $16,665

Depreciation Year 2 = 44.45% * $50,000
Depreciation Year 2 = $22,225

Depreciation Year 3 = 14.81% * $50,000
Depreciation Year 3 = $7,405

Book Value at the end of Year 3 = $50,000 - $16,665 - $22,225 - $7,405
Book Value at the end of Year 3 = $3,705

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $19,400 - ($19,400 - $3,705) * 0.34
After-tax Salvage Value = $14,063.70

Initial Investment in NWC = $1,400

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$50,000 - $1,400
Net Cash Flows = -$51,400

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $17,100 * (1 - 0.34) + 0.34 * $16,665
Operating Cash Flow = $16,952.10

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $16,952.10

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $17,100 * (1 - 0.34) + 0.34 * $22,225
Operating Cash Flow = $18,842.50

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $18,842.50

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $17,100 * (1 - 0.34) + 0.34 * $7,405
Operating Cash Flow = $13,803.70

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $13,803.70 + $1,400 + $14,063.70
Net Cash Flows = $29,267.40