Question

Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $35,000; it is now five years old, and it has a current market value of $15,000.00. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $17,500 and an annual depreciation expense of $3,500. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $4,200 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 30 percent tax rate.

What will the cash flows for this project be?

re

Year	0	1	2	3	4	5	6
FCF	$	$	$	$	$	$	$

rev: 04_25_2018_QC_CS-125254

Answer 1

Calculation of cash flows of project
Year	0	1	2	3	4	5	6
Cost of new oven	-$27,000.00
After tax salvage value of old oven	$15,750.00
Cash savings		$4,200.00	$4,200.00	$4,200.00	$4,200.00	$4,200.00	$4,200.00
Tax @ 30% on cash savings		-$1,260.00	-$1,260.00	-$1,260.00	-$1,260.00	-$1,260.00	-$1,260.00
Additional depreciation tax shield		$570.00	$1,542.00	$505.20	-$116.88	-$116.88	$466.56
Cash flows	-$11,250.00	$3,510.00	$4,482.00	$3,445.20	$2,823.12	$2,823.12	$3,406.56
Working
Calculation of depreciation per year on old oven
Depreciation per year = [Cost -salvage value]/useful life = $35000 / 10 years = $3500
Calculation of depreciation on new oven using 5 year MACRS rates
Year	Cost	Depreciation rates	Depreciation
1	27000	20%	5400
2	27000	32%	8640
3	27000	19.20%	5184
4	27000	11.52%	3110.4
5	27000	11.52%	3110.4
6	27000	5.76%	1555.2
Calculation of additional depreciation and tax shield
Year	Old Oven	New Oven	Additional Depreciation	Tax shield @ 30%
1	3500	5400	1900	570
2	3500	8640	5140	1542
3	3500	5184	1684	505.2
4	3500	3110.4	-389.6	-116.88
5	3500	3110.4	-389.6	-116.88
6		1555.2	1555.2	466.56
After tax salvage value of old oven
Sale value of old oven	15000
Less : Book value of old oven	17500
Loss on sale	2500
Tax shield @ 30% on loss	750
After tax salvage value of old oven	15750