Question

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $50,000. The truck falls into the MACRS 3-year class, and it will be sold after three years for $21,000. Use of the truck will require an increase in NWC (spare parts inventory) of $3,000. The truck will have no effect on revenues, but it is expected to save the firm $16,900 per year in before-tax operating costs, mainly labor. The firm’s marginal tax rate is 34 percent.

What will the cash flows for this project be? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)

Answer 1

Cost of Truck = $50,000

Depreciation Year 1 = 33.33% * $50,000
Depreciation Year 1 = $16,665

Depreciation Year 2 = 44.46% * $50,000
Depreciation Year 2 = $22,225

Depreciation Year 3 = 14.81% * $50,000
Depreciation Year 3 = $7,405

Book Value at the end of Year 3 = $50,000 - $16,665 - $22,225 - $7,405
Book Value at the end of Year 3 = $3,705

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * Tax Rate
After-tax Salvage Value = $21,000 - ($21,000 - $3,705) * 0.34
After-tax Salvage Value = $15,119.70

OCF Year 1 = Cost Saving * (1 - tax) + tax * Depreciation
OCF Year 1 = $16,900 * (1 - 0.34) + 0.34 * $16,665
OCF Year 1 = $16,820.10

OCF Year 2 = Cost Saving * (1 - tax) + tax * Depreciation
OCF Year 2 = $16,900 * (1 - 0.34) + 0.34 * $22,225
OCF Year 2 = $18,710.50

OCF Year 3 = Cost Saving * (1 - tax) + tax * Depreciation
OCF Year 3 = $16,900 * (1 - 0.34) + 0.34 * $7,405
OCF Year 3 = $13,671.70

Net Cash Flows Year 0 = Cost of Truck + Initial NWC Investment
Net Cash Flows Year 0 = -$50,000 - $3,000
Net Cash Flows Year 0 = -$53,000

Net Cash Flows Year 1 = OCF
Net Cash Flows Year 1 = $16,820.10

Net Cash Flows Year 2 = OCF
Net Cash Flows Year 2 = $18,710.50

Net Cash Flows Year 3 = OCF + After-tax Salvage Value + NWC recovered
Net Cash Flows Year 3 = $13,671.70 + $15,119.70 + $3,000
Net Cash Flows Year 3 = $31,791.40