Question

MACRS Depreciation Allowances
Property Class
Year	3-Year	5-Year	7-Year
1	33.33%	20.00%	14.29%
2	44.45	32.00	24.49
3	14.81	19.20	17.49
4	7.41	11.52	12.49
5		11.52	8.93
6		5.76	8.92
7			8.93
8			4.46

Use the following information to answer the next three questions:

Some new equipment under consideration will cost $2,600,000 and will be used for 4 years. Net working capital will experience a one time increase of $559,000 if the equipment is purchased. The equipment is expected to generate annual revenues of $1,800,000 and annual costs of $576,000. The project falls under the seven-year MACRs class for tax purposes, the tax rate is 32 percent, and the cost of capital is 12 percent. The project's fixed assets can be sold for $624,000 at the end of the project's life.

Show ALL your work.

a) What is the book value of the equipment at the end of the project's life? Round your answer to the nearest whole dollar.

b) What are the taxes on the sale of the equipment at the end of the project's life? Be sure to indicate clearly if taxes are owed or if there is a tax benefit. Round your answer to the nearest whole dollar.

c) What is the net cash flow for the last year of the project? Round your answer to the nearest whole dollar.

Answer 1

Answer to Question a)

7 years MACRS Depreciation
Cost of the Asset		$2,600,000.00
Years	Rate	Depreciation
1	14.29%	371,540
2	24.49%	636,740
3	17.49%	454,740
4	12.49%	324,740
Total Depreciation		178,7760

Book Value at the end of the project = Original Cost -Total depreciation till end of the project.

=$812,240.00

Answer to Question b) Book Value of the asset is $812,240.00

Sale Value of Asset is $624,000.

Sale value of asset is less than Book Value, So loss on Sale of Asset is $188,240

So tax savings = $188,240 x 32% = $60,236.8 Rounded to nearest $=$60,237

Answer to Question c)

Net Cash flow for the last year = Last year operating Cash flow+Terminal Cash flow,

Last year Operating Cash flow = Annual Revenue - Annual Cost - Depreciation- Tax+ Depreciation

Last year Revenue		$18,00,000.00
Last year cost		$5,76,000.00
Last year Depreciation		$3,24,740.00
Last year PBT		$8,99,260.00
Last Year Tax @ 32%		$2,87,763.20
Last year PAT		$6,11,496.80
Add: Depreciation		$3,24,740.00
Last year Annual Cash flow		$9,36,236.80
Terminal Cash flow
Book Value of Asset		$8,12,240.00
Sale Value		$6,24,000.00
Loss on Sale of Asset		$1,88,240.00
Tax Savings on Loss of Asset		$60,236.80
Total cash inflow@ terminal		$6,84,236.80

It is Assumet that Comapy is eligible to take advantage of Tax Savings and allowed by Tax Authority.

Tax savings on loss of Asset is to be added with sale value of Asset.

So total cash flow at the last year =$684,236.80+$936,236.80 = $1,620,473.6,

Rounded to nearest Dollar = $1,620,474.

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