Overarmour Corp. is in the evaluation process for the acquisition of a new machine with 6...

Overarmour Corp. is in the evaluation process for the acquisition of a new machine with 6 years productive life (5 years MACRS). The new machine with a total cost of $90,000 will produce earnings before depreciation and taxes of $25,000 during years 1 - 3 and $20 during years 4 - 6. Overarmour cost of capital is 12.5% and the corporate tax rate is 35%.

How much will be the depreciation expense for year 1 and year 3? How much will be cash flows for year 2? What is the payback period of the new machine?

Expert Solution

Solution) Purchase Price = $90,000

Depreciation schedule as per the 5-year MACRS is:

Depreciation amount is calculated as = Depreciation (%) for the year * Purchase Price

Example: For Year 1, Depreciation amount = 20%*90000 = 18,000

The operating cash flows are shaown as:

Earnings before tax = Earnings before depreciation and taxes - Depreciation

Tax expense = Tax rate * Earnings before tax = 35%*Earnings before tax

Net operating cash flows = Earnings before tax + Depreciation

The payback period is calculated as follows:

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jeff jeffy answered 1 year ago

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