Question

Big-Pear Corp. is considering replacing its existing equipment that is used to produce smart cell phones. This existing equipment was purchase 3 years ago at a base price of $44,000. Installation costs at the time for the machine were $8,000. The existing equipment is considered a 5-year class for MACRS. The existing equipment can be sold today for $40,000 and for $20,000 in 3 years. The new equipment has a purchase price of $138,000 and is also considered a 5-year class for MACRS. Installation costs for the new equipment are $6,000. The estimated salvage value of the new equipment is $80,000. This new equipment is more efficient than the existing one and thus savings before taxes using the new equipment are $15,000 a year. Due to these savings, inventories will see a one time reduction of $4,000 at the time of replacement. The company's marginal tax rate is 37% and the cost of capital is 12%. For this project, what is the incremental cash flow in year 1?

MACRS Fixed Annual Expense Percentages by Recovery Class
Year	3-Year	5-Year	7-Year	10-Year	15-Year
1	33.33%	20.00%	14.29%	10.00%	5.00%
2	44.45%	32.00%	24.49%	18.00%	9.50%
3	14.81%	19.20%	17.49%	14.40%	8.55%
4	7.41%	11.52%	12.49%	11.52%	7.70%
5		11.52%	8.93%	9.22%	6.93%
6		5.76%	8.93%	7.37%	6.23%
7			8.93%	6.55%	5.90%
8			4.45%	6.55%	5.90%
9				6.56%	5.91%
10				6.55%	5.90%
11				3.28%	5.91%
12					5.90%
13					5.91%
14					5.90%
15					5.91%
16					2.95%

Answer 1

Incremental cash flow in year 1=

Savings after taxes + Incremental depreciation * tax rate

Here, Incremental depreciation= Depreciation on new equipment less depreciation in existing equipment

=(138000+6000)*20% - (44000+8000)*11.52%

=28800-5990.4=22,809.6

Incremental cash flow in year 1 =

15000*(1-0.37) + 22809.6*0.37

=9450+8439.552

=$ 17,889.552