Question

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $340,000. The truck falls into the MACRS 5-year class, and it will be sold after 5 years for $59,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,900. The truck will have no effect on revenues, but it is expected to save the firm $86,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. What will the cash flows for this project be during year 3?

a) $12,432

b) $77,712

c) $116,880

d) $68,000

Answer 1

Computation of depreciation:

MACRS Depreciation Schedule 5 year
Year	Cost	MACRS %	Depreciation (Cost x MACRS %)
1	$ 340,000	20	$                68,000
2		32	$              108,800
3		19.2	$                65,280
4		11.52	$                39,168
5		11.52	$                39,168
6		5.76	$                19,584

Depreciation in year 3 = $ 65,280

Computation of Cash flow in year 3:

Annual cost savings	$ 86,000
Less: Depreciation	$ 65,280
PBT	$ 20,720
Less: Tax @ 40 %	$ 8,288
PAT	$ 12,432
Add: Depreciation	$ 65,280
Cash flow	$77,712

Cash flow in year 3 is $ 77,712

Hence option “b) $ 77,712” is correct answer.