Question

 Looner Industries is currently analyzing the purchase of a new machine that costs $ 159,000 and requires $ 19,500 in installation costs. Purchase of this machine is expected to result in an increase in net working capital of $ 29,800 to support the expanded level of operations. The firm plans to depreciate the machine under MACRS using a​ 5-year recovery period​

Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes
	Percentage by recovery​ year*
Recovery year	3 years	5 years	7 years	10 years
1	33​%	20​%	14​%	10​%
2	45​%	32​%	25​%	18​%
3	15​%	19​%	18​%	14​%
4	7​%	12​%	12​%	12​%
5		12​%	9​%	9​%
6		55%	9​%	8​%
7			9​%	7​%
8			4​%	6​%
9				6​%
10				6​%
11				4​%
Totals	100​%	100​%	100​%	100​%

and expects to sell the machine to net $ 9,700 before taxes at the end of its usable life. The firm is subject to a 40 % tax rate.

a. Calculate the terminal cash flow for a usable life of ​ (1) 3​ years, (2) 5​ years, and​ (3) 7 years.

b. Discuss the effect of usable life on terminal cash flows using your findings in part a.

c.  Assuming a​ 5-year usable​ life, calculate the terminal cash flow if the machine were sold to net​ (1) $ 8,925 or​ (2) $ 169,300 ​(before taxes) at the end of 5 years. d. Discuss the effect of sale price on terminal cash flow using your findings in part c. a. Calculate the terminal cash flow for a usable life of ​ (1) 3​ years, (2) 5​ years, and​ (3) 7 years. The following table can be used to solve for the terminal cash​ flow:  ​(Round to the nearest​ dollar.) 3-year Proceeds from sale of proposed asset $ +/- Tax on sale of proposed asset $ Total after-tax proceeds-new $ + Change in net working capital $ Terminal cash flow $

Answer 1

Required a

Terminal Cash Flow (3 years)

Particulars	Amount
Proceeds from sale	$9,700
Less: Tax on sale (9700 - 0) * 40%	$3,880
Total after tax proceeds	$5,820
Change in net working capital	29,800
Terminal Cash Flow	35,620

Terminal Cash Flow (5 years)

Particulars	Amount
Proceeds from sale	$9,700
Less: Tax on sale (9700 - 0) * 40%	$3,880
Total after tax proceeds	$5,820
Change in net working capital	29,800
Terminal Cash Flow	35,620

Terminal Cash Flow (7 years)

Particulars	Amount
Proceeds from sale	$9,700
Less: Tax on sale (9700 - 0) * 40%	$3,880
Total after tax proceeds	$5,820
Change in net working capital	29,800
Terminal Cash Flow	35,620

Required b

If the asset is to be sold at the same price of $9700 at the end of the life, there would be no effect of change in the life of the asset on the terminal cash flow.

Required c

Terminal Cash Flow (5 years) Sales Price $8925

Particulars	Amount
Proceeds from sale	$8,925
Less: Tax on sale (8925 - 0) * 40%	$3,570
Total after tax proceeds	$5,355
Change in net working capital	29,800
Terminal Cash Flow	35,155

Terminal Cash Flow (5 years) Sales Price $169,300

Particulars	Amount
Proceeds from sale	$169,300
Less: Tax on sale (169300 - 0) * 40%	$67,720
Total after tax proceeds	$101,580
Change in net working capital	29,800
Terminal Cash Flow	$131,380

Required d

The effect of sales price on the terminal cash flow is such that, the more the sales price, the more is the terminal cash flow.