Question

A manufacturer of electronic components acquires a cutting machine (CM) for $400,000. It is estimated that the CM will reduce operating costs by $128,000 annually, since it is capable of cutting through high-thickness green ceramic ware. It will be depreciated using the MACRS method, with a recovery period of five years. The project period is six years; it is estimated that the CM will have a market value equal to 10% of its purchase price at the end of the project period. This company has an after-tax MARR of 12% and a 25% combined federal/state rate.

Compute the after-tax cash flows

Answer 1

Cost of cutting machine = $400,000

Annual reducing operating cost = $128000

Life of the project = 6 years

MARR = 12%

Tax rate =25%

Salvage value at the end of year 6 = ($400000 * 10%) = $40000

There is tax benefit on the depreciation amount = Depreciation amount * Tax rate

Calculation of depreciation Under MARCS method
Year	Value of assets	% of depreciation	Depreciation value	Remaining value
1	400000	20.00	80000	320000
2	320000	32.00	102400	217600
3	217600	19.20	41779.2	175820.8
4	175821	11.52	20254.6	155566.2
5	155566	11.52	17921.2	137645.0
6	137645	5.76	7928.4	129716.7

Calculation of after tax cash flow
Year	Saving in operating cost	After tax Saving	Depreciation amount	Tax benefit of depreciation	Total after tax saving
1	$128,000	96000	80000	20000	116000
2	$128,000	96000	102400	25600	121600
3	$128,000	96000	41779.2	10444.8	106444.8
4	$128,000	96000	20254.6	5063.65	101063.65
5	$128,000	96000	17921.2	4480.3	100480.3
6	$128,000	96000	7928.4	1982.1	97982.1
Total					643570.85

Remaining value at the end of year 6 = $129716.7

Salvage value at the end of the year 6 = $40000

loss on sale = ( $129716.7 - $40000 )   = $89716.70

Tax benefit on loss in year 6 = $89716.70 * 25% = $22429.18

After tax cash flow
Year	Cash flow	Present value factor	Present value
1	116000.00	0.893	103588.00
2	121600.00	0.797	96915.20
3	106444.80	0.712	75788.70
4	101063.65	0.635	64175.42
5	100480.30	0.567	56972.33
6	97982.10	0.507	49676.92
6	22429.18	0.507	11371.59
Total			458488.16