Question

X Company is considering a new processor that costs $150,000. Shipping and setup costs for the new processor are estimated to be $15,000. X’s working capital requirement is expected to increase by $17,000 when the new processor begins operation and is expected to be fully recoverable at the end of the project. The new processor’s useful life is expected to be 5 years and its salvage value at that point is estimated to be $60,000. The new processor is being depreciated using a 5-year ACRS life. Assume a tax rate of 35% and a cost of capital of 12%. Estimated incremental revenues and incremental cash operating expenses for the new processor before tax for each year are shown in the table below. Year Revenues Operating Expenses 1: $87,000 $23,000 2: $82,000 $25,000 3: $93,000 $30,000 4: $87,000 $23,000 5: $88,000 $29,000 The processor will be depreciated to a zero book value using the following annual depreciation rates that are applied to the original installed cost. Year Depreciation % 1: 15 2: 22 3 - 5: 21 A) What is the book value of the new processor at the end of Year 3? B) What is the incremental after-tax cash flows in Year 4? C) What is the total after-tax cash flows in Year 5? Total means incremental cash flows plus terminal cash flows.

Answer 1

Processor Capitalized Cost
Processor cost	$         150,000
Shipping & Set up cost	$           15,000
Total Captalized cost	$         165,000

Depreciation details	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Depreciation Rates		15%	22%	21%	21%	21%
Annual Depreciation expense		$             24,750	$         36,300	$             34,650	$         34,650	$        34,650

Book Value after 5 years	$                    -
Salvage value after 5 years	$           60,000
Capital Gain	$           60,000
Tax on Capital Gain @35% =	$           21,000
After Tax salvage value	$           39,000

Ans A.
Total Captalized cost of Processor	$         165,000
Accumulated depreciation upto year 3	$           95,700
Book Value of Processor at the end of year 3	$           69,300

	Cash flow details	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
	Capitalized cost of Processor	$       (165,000)
	Investment in NWC	$          (17,000)
a	Total Initial Investment	$       (182,000)
	Cash flow from operations
b	Incremental sales revenue		$             87,000	$         82,000	$             93,000	$         87,000	$        88,000
c	Less Incremental cash operating expense		$             23,000	$         25,000	$             30,000	$         23,000	$        29,000
d	Less Depreciation expense		$             24,750	$         36,300	$             34,650	$         34,650	$        34,650
e	Taxable Income=b-c-d		$             39,250	$         20,700	$             28,350	$         29,350	$        24,350
f	Tax @ 35%		$        13,737.50	$      7,245.00	$         9,922.50	$   10,272.50	$     8,522.50
g	After Tax incremental income		$        25,512.50	$    13,455.00	$       18,427.50	$   19,077.50	$   15,827.50
h	Add back depreciation		$             24,750	$         36,300	$             34,650	$         34,650	$        34,650
i	Net Incremental Cash flow from operations=g+h=		$        50,262.50	$    49,755.00	$       53,077.50	$   53,727.50	$   50,477.50
j	Terminal Cash flow:
k	After Tax salvage value						$        39,000
l	Return of NWC						$        17,000
m	Total after Tax Terminal Cash flow						$        56,000
n	Total Cash flow from project=a+i+m	$      (182,000)	$            50,263	$        49,755	$            53,078	$        53,728	$     106,478

Ans C.
Total After Tax cash flows in year 4=	$           53,728
Ans D.
Total After Tax cash flows in year 5=	$         106,478