Question

Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $47,000; it is now five years old, and it has a current market value of $22,000. 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 $23,500 and an annual depreciation expense of $4,700. 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 $26,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $2,900 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 35 percent tax rate. What will the cash flows for this project be? (Note that the $47,000 cost of the old oven is depreciated over ten years at $4,700 per year. The half-year convention is not used for the old oven. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places.) Year 0 1 2 3 4 5 6 FCF $ $ $ $ $ $ $

Answer 1

Book value of old Oven after 5 Years		23500		Year	Cost of new equipment	Macrs rate	Annual depreciation	Depreciation on old Oven	incremental depreciation
selling price of old Oven		22000		1	26000	20%	5200	4700	500
loss on sale of old oven		-1500		2	26000	32%	8320	4700	3620
tax benefit on loss on sale of old oven	1500*35%	525		3	26000	19.20%	4992	4700	292
total benefit from sale of old oven	22000+525	22525		4	26000	11.52%	2995.2	4700	-1704.8
				5	26000	11.52%	2995.2	4700	-1704.8
cost of new oven		26000		total depreciation charged on new oven			24502.4
less total benefits from sale of old equipment		22525
net cash outflow		3475		Year	0	1.00%	2	3	4	5
				cash outflow	-3475
tax benefit on disposal of of new oven	(26000-24502.4)*35%	524.16		before tax cash savings		2900	2900	2900	2900	2900
				less incremental depreciation		500	3620	292	-1704.8	-1704.8
				before tax after depreciation cash savings		2400	-720	2608	4604.8	4604.8
				after tax cash savings		1560	-468	1695.2	2993.12	2993.12
				add incremental depreciation		500	3620	292	-1704.8	-1704.8
				tax benefit on disposal of new oven						524.16
				net operating cash flow	-3475	2060	3152	1987.2	1288.32	1812.48