Question

Big-Pear Corp. is considering replacing its existing equipment that is used to produce smart cell phones. This existing equipment was purchase 2 years ago at a base price of $50,000. Installation costs at the time for the machine were $7,000. 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 4 years. The new equipment has a purchase price of $140,000 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 in year 4 is $90,000. This new equipment is more efficient than the existing one and thus savings before taxes using the new equipment are $12,000 a year. Due to these savings, inventories will see a one time reduction of $2,000 at the time of replacement. The company's marginal tax rate is 40% and the cost of capital is 12%.

MACRS 5 year

Year	5-year
1	20.00%
2	32.00%
3	19.20%
4	11.52%
5	11.52%
6	5.76%

For this project, what is the incremental cash flow in year 3?

The answer (incremental cash flow in year 3) is 17,100.

Please help me with the steps/work required to arrive at this value. Thank you.

Answer 1