Question

City Security is considering a project with an initial fixed asset cost of $5,600,000 which will be depreciated on the MACRS 5-year class over the 5-year of the project. At the end of the project, the book value will be zero and the equipment will be sold for an estimated $2,800,000. The project will not directly produce any sales but will save the firm $1,000,000 per year in pretax operating cost. The system requires an initial investment in net-working capital of $290,000.The tax rate is 35%. What is the after-tax salvage value of the equipment after 5 years? What are the depreciation and operating cash flows of each year i.e. from year 1 to year 5? Show your calculation

Year	5-year MACRS percent
1	20%
2	32%
3	19.2%
4	11.5%
5	11.5%
6	5.8%

Thanks very much

Answer 1

1. Calculation of the yearly depriciation

Intial Cost = $5,600,000

S.No	Depriciation Rate	Deprciation Amount
1	20%	$1120,000 ($5,600,000*20%)
2	32%	$1,792,000($5,600,000*32%)
3	19.2%	$1,075,200 ($5,600,000*19.2%)
4	11.5%	$644,000 ($5,600,000*11.5%)
5	11.5%	$644,000 ($5,600,000*11.5%)
6	5.8%	$324,800 ($5,600,0008*5.8%)

2. Calculation of after tax salvage value.

The equipment will have a book value at the end of five years 5.8%$5,600,000= $324,800

So the after tax salvage value = Book Value+( Market Value- Book Value)x (1- Tax Rate)

=$324,800+ ($2,800,000- $ 324,800)x(1-.35)

   =$1,933,680

3. Calculations of operating cash flows

Intial cash outlay= Cost of equipment + Net working capital required

   = $5,600,000+ $290,000

   = $5,890,000

Operating Cash flows for the year 1 to 5

1.S.No	2.Pretax Saving in Operating Cost	3.Depriciation	4.Cash Flow Pre Tax(2+3)	5.Tax Rate	6.Cash Flow post Tax(4-(4x5))
1	$1,000,000	$1,120,000	$2120000	35%	$1378000
2	$1,000,000	$1,792,000	$2792000	35%	$1814800
3	$1,000,000	$1,075,200	$2075200	35%	$1348880
4	$1,000,000	$644,000	$1644000	35%	$1068600
5	$1,000,000	$644,000	$1644000	35%	$1068600