Question

1. (Identifying cash flows) An analyst has prepared the following data as part of a proposal to acquire a new machine:

cost to purchase machine $40,000

cost to install machine 1,000

cost of new electric wiring 2,000

first year depreciation of machine 4,000

sales tax on purchasing machine 3,000

economic salvage value of the machine 10,000

accounting salvage value of the machine 8,000

a. Which of the above figures should enter the capital budgeting analysis?

b. What figure should enter the capital budgeting analysis as the investment at year zero?

c. Which of the above figures should not enter the capital budgeting analysis?

d. Will any of the items you list in part c have a later impact on the firm’s cash flows? If so, what?

Answer 1

ANS: Currency in $

(a) The following figures are used in capital budgeting analysis are :-

• cost to purchase machine = 40,000
• cost to install machine = 1,000
• cost of new electric wiring = 2,000
• first year depreciation of machine = 4,000
• sales tax on purchasing machine = 3,000
• economic salvage value of the machine = 10,000

(b) Figures used in Capital Budgeting analysis as the investment at year 0 are-

• cost to purchase machine = 40,000
• cost to install machine = 1,000
• cost of new electric wiring = 2,000

Since the above cost are to be capitalised & are incurred at year 0.

(c) Figures not used in Capital Budgeting analysis are -

• accounting salvage value of the machine = 8,000

(d) Yes, Item mentioned in part (c) may have later impact on firm's cash flow.

Reasons -

Economic salvage value is the estimated resale value of the assets at the end of its useful life. Whereas Accounting Salvage value is the estimated book value of the assets after depreciation is complete. If a company sells an assets with a salvage value higher than its book value then the company has to pay taxes on account of future profit.