Question

In: Finance

The XYZ Company is evaluating the acquisition of new equipment. The equipment’s base price is $150,000,...

The XYZ Company is evaluating the acquisition of new equipment. The equipment’s base price is $150,000, and it would cost another $16,000 to modify it for special use by the firm. The equipment falls into the MACRS 3-year class (33% depreciation in year 1, 45% in year 2, 15% in year 3, and 7% in year 4), and it would be sold after 3 years for $75,000. The equipment will require an increase in net working capital of $7,500. The equipment will have no effect on revenues, but it is expected to save the firm $48,000 per year in before tax operating costs, mainly labor. The firm’s marginal tax rate is 30%.

  1. What is the net outlay for the equipment?
  2. What are the net cash inflows in years 1, 2, and 3?

Solutions

Expert Solution

Answer : Calculation of Net Outlay for the equipment

Net Outlay = Base Price + Cost to Modify + Increase in Net Working Capital

= 150000 + 16000 + 7500

= 173500

Below is the Table showing Net Cash Inflows for year 1 , 2 and 3:

Year 0 Year 1 Year 2 Year 3
Initial Investment (150000+16000) 166000
Before tax Opearting Cost Savings 48000 48000 48000
Less : Depreciation (Working Note) 54780 74700 24900
Earning before taxes -6780 -26700 23100
Taxes @ 30% -2034 -8010 6930
Net Income -4746 -18690 16170
Add : Depreciation 54780 74700 24900
Add: Salvage Value 75000
Less : Tax on Sale 19014
Net Working Capital 7500
Recapture of Net Working Capital 7500
Net Cash InFlows 173500 50034 56010 104556
Working Note :
Calculation of Depreciation
Year 1 = 166000 * 33% = 54780
Year 2 = 166000 * 45% = 74700
Year 3 = 166000 * 15% = 24900
Book Value at the end of year 3 = 166000 - 54780 - 74700 - 24900 = 11620
Gain on Sale = 75000 - 11620 = 63380
Tax on Gain on sale = 63380 * 30% = 19014

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