Question

Russell Industries is considering replacing a fully depreciated machine that has a remaining useful life of 10 years with a newer, more sophisticated machine. The new machine will cost $350,000 and will require $30,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. A $25,000 increase in net working capital will be required to support the new machine. The firm’s managers plan to evaluate the potential replacement over a 4-year period. They estimate that the old machine could be sold at the end of 4 years to net $15,000 before taxes; the new machine at the end of 4 years will be worth $75,000 before taxes. Calculate the terminal cash flow at the end of year 4 that is relevant to the proposed purchase of the new machine. The firm is subject to a 40% tax rate.
Select one:
a. 93,640
b. 83,440
c. 90,240
d. 86,840

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Abdul-Rahim Taysir

Answer 1

1]	Book value of the machine at EOY 4 = (350000+30000)*(12%+7%) =	$             64,600
	Sale value at EOY 4	$             75,000
	Gain on sale	$             10,400
	Tax gain at 40%	$               4,160
	After sale value of new machine	$             70,840
2]	Less: After tax salve value lost on old machine = 15000*(1-40%) =	$               9,000
3]	Add: Release of NWC	$             25,000
4]	Terminal cash flow at EOY 4	$             86,840
	Answer: [d] $86,840