Question
In: Finance
You have been asked by the president of your company to evaluate the proposed acquisition of...
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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 $19,400. Use of the truck will require an increase in NWC (spare parts inventory) of $1,400. The truck will have no effect on revenues, but it is expected to save the firm $17,100 per year in before-tax operating costs, mainly labor. The firm’s marginal tax rate is 34 percent. |
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What will the cash flows for this project be? |
Solutions
Expert Solution
MACRS 3-years class rates are 33.33%, 44.45%, 14.81% and 7.41% for years 1,2,3 and 4 respectively.
| Year | Depreciation | Depreciation tax shield |
| 1 | $50,000 x 33.33% = $16,665 | $16,665 x 34% = $5,666.10 |
| 2 | $50,000 x 44.45% = $22,225 | $22,225 x 34% = $7,556.50 |
| 3 | $50,000 x 14.81% = $7,405 | $7,405 x 34% = $2,517.70 |
Book value of truck at the end of year 3 = $50,000 - $16,665 - $22,225 - $7,405 = $3,705
Tax on Gain on salvage value = ($19400 - $3705) x 34% = $5,336.30
| Particulars | Year 0 | Year 1 | Year 2 | Year 3 |
| Cost of truck | ($50,000) | |||
| Increase in NWC | ($1,400) | |||
| Savings in operating costs net of tax [$17,100 x (1 - 0.34)] | $11,286 | $11,286 | $11,286 | |
| Add: Depreciation tax shield | $5,666.10 | $7,556.50 | $2,517.70 | |
| Add: Salvage value net of tax ($19,400 - $5,336.30) | $14,063.70 | |||
| Add: NWC recovered | $1,400 | |||
| Cash Flows | ($51,400) | $16,952.10 | $18,842.50 | $29,267.40 |
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