Question

Big-Pear Corp. is considering replacing its existing equipment that is used to produce smart cell phones. This existing equipment was purchase 2 years ago at a base price of $60,000. Installation costs at the time for the machine were $7,000. The existing equipment is considered a 5-year class for MACRS. The existing equipment can be sold today for $40,000 and for $30,000 in 4 years. The new equipment has a purchase price of $120,000 and is also considered a 5-year class for MACRS. Installation costs for the new equipment are $6,000. The estimated salvage value of the new equipment in year 4 is $80,000. This new equipment is more efficient than the existing one and thus savings before taxes using the new equipment are $11,000 a year. Due to these savings, inventories will see a one time reduction of $2,000 at the time of replacement. The company's marginal tax rate is 30% and the cost of capital is 12%. For this project, what is the incremental cash flow in year 3?

MACRS Fixed Annual Expense Percentages by Recovery Class
Year	3-Year	5-Year	7-Year	10-Year	15-Year
1	33.33%	20.00%	14.29%	10.00%	5.00%
2	44.45%	32.00%	24.49%	18.00%	9.50%
3	14.81%	19.20%	17.49%	14.40%	8.55%
4	7.41%	11.52%	12.49%	11.52%	7.70%
5		11.52%	8.93%	9.22%	6.93%
6		5.76%	8.93%	7.37%	6.23%
7			8.93%	6.55%	5.90%
8			4.45%	6.55%	5.90%
9				6.56%	5.91%
10				6.55%	5.90%
11				3.28%	5.91%
12					5.90%
13					5.91%
14					5.90%
15					5.91%
16					2.95%

For your answer, round to the nearest dollar, do not enter the $ sign, use commas to separate thousands, use a negative sign in front of first number is the cash flow is negative (do not use parenthesis to indicate negative cash flows). For example, if your answer is $3,005.87 then enter 3,006; if your answer is -$1,200.25 then enter -1,200

For this project, the incremental cash flow in year 3 is:

Your Answer:

Answer 1

Net incremental cash flow of year 3 = $12,642

Explanation: -

Savings	$11,000
Less Depreciation	24,192
loss before tax	(13,192.00)
Tax (30%)	(3,957.60)
Net loss	(9,234.40)
Add Depreciation	24,192.00
net cash flow	$14,957.6
Less cash flow from existing machine: Depreciation shield of old machine	$2315.5
Net incremental cash flow of year 3	$12,642

NOTES: -

1.) Depreciation of new machine: -

Total cost of new machine = purchase price + Installation costs

=$120,000 + $6,000

=$126,000

Depreciation of year 3 = Total cost of new machine * depreciation rate

Depreciation of year 3 = $126,000 * 19.20%

Depreciation of year 3 = $24,192

2.) Depreciation shield of old machine: -

Total cost of new machine = purchase price + Installation costs

=$60,000 + $7,000

=$67,000

Depreciation of year 3 = Total cost of new machine * depreciation rate

Depreciation of year 3 = $67,000 * 11.52%(year 5)

Depreciation of year 3 = $7,718.4

Depreciation shield of old machine = Depreciation * tax rate

= $7.718.4 * 30%

= $2315.5