Question

Mom's Cookies Inc. is considering the purchase of a new cookie oven. The original cost of the old oven was $30,000; it is now fie years old, and it has a current market value of $13,333.33. 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 $15,000 and an annual depreciation expense of $3,000. 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 $25,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $4,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life, and the cost of capital is 10 percent. Assume a 40 percent tax rate. What will the cash flows for this project be? (LG5)

I have to show the work and I do not get it. There is no missing data this is the entire question. Please tell me what data is missing?

Answer 1

1. Computation of Incremental Depreciation :

Year	MACRS Depreciation Rate	Depreciation : New Equipment	Depreciation : Old Equipment	Incremental Depreciation
		$	$	$
1	20%	5,000	3,000	2,000
2	32%	8,000	3,000	5,000
3	19.2%	4,800	3,000	1,800
4	11.52%	2,880	3,000	(120)
5	11.52%	2,880	3,000	(120)
6	5.76%	1,440	0	1,440
		$ 25,000	$ 15,000	$ 10,000

Net Initial Investment:

	$
Cost of New Equipment	25,000
Less: Salvage Value of Old Equipment	13,333.33
Less: Tax effect of loss on salvage $ ( 13,333.33 - 15,000) x 40%	666.67
Net Initial Investment	$ 11,000

Incremental Operating Cash Flows After Taxes:

	0	1	2	3	4	5	6
	$	$	$	$	$	$	$
Net Initial Investment	(11,000)
Incremental EBITDA		4,000	4,000	4,000	4,000	4,000	4,000
Incremental Depreciation		2,000	5,000	1,800	(120)	(120)	1,440
Operating Cash Flows After Tax *		3,200	4,400	3,120	2,352	2,352	2,976
Total Cash Flows	( 11,000)	3,200	4,400	3,120	2,352	2,352	2,976

* Operating cash flows after tax = Incremental EBITDA * ( 1 - t ) + Incremental Depreciation x t.