Question

Joe 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?

Answer 1

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