Question

The J. J. Hill Company is considering new digging equipment machine. The existing digging equipment cost $1,000,000 five years ago and is being depreciated using MACRS, when classified as a 5-year asset. Hill's management estimates the old equipment can be sold for $200,000. The new equipment costs $1,200,000 and would be depreciated over five years using MACRS. At the end of the fifth year, Hill's management intends to sell the new equipment for $400,000. The new equipment is more efficient and would reduce expense by $200,000 per year for the next five years. The marginal tax rate is 35%.

(a) What are the cash flows related to the acquisition of the new equipment?

(b) What are the cash flows related to the disposition of the old equipment?

(c) What are the cash flows related to the disposition of the new equipment?

(d) What are the operating cash flows for each year?

(e) What the net cash flows for each year?

Answer 1

a)	Cash outflow for acquisition of new machine =	1200000	Answer
b)	Sale value of old machine	200000
	Book Value of old machine = 1000000*5.76% (6th year depreciation) =	57600
	Gain on sale	142400
	Tax on gain = 142400*35% =	49840
	NET AFTER TAX CASH INFLOW ON SALE OF OLD MACHINE = 200000-49840 =	150160	Answer
c)	Sale value of the new machine at t5	400000
	Book value at t5 = 1200000*5.76% =	69120
	Gain on sale	330880
	Tax on gain = 330880*35% =	115808
	NET AFTER TAX CASH INFLOW ON SALE OF NEW MACHINE = 400000-115808 =	284192	Answer
d)		0	1	2	3	4	5
	Before tax savings in expense		200000	200000	200000	200000	200000
	Depreciation (MACRS 5 Year)		240000	384000	230400	138240	138240
	Net savings before tax		-40000	-184000	-30400	61760	61760
	Tax at 35%		-14000	-64400	-10640	21616	21616
	Net savings after tax		-26000	-119600	-19760	40144	40144
	Add: Depreciation		240000	384000	230400	138240	138240
	Annual OCF		214000	264400	210640	178384	178384
e)	Capital expenditure	1049840					-284192
	Net cash flows for each year	-1049840	214000	264400	210640	178384	462576