Question

Top-Ten Inc. is considering replacing its existing machine that is used to produce musical CDs. This existing machine was purchase 3 years ago at a base price of $50,000. Installation costs at the time for the machine were $1,000. The existing machine is considered a 3-year class for MACRS. The existing machine can be sold today for $40,000 and for $10,000 in 3 years. The new machine has a purchase price of $90,000 and is also considered a 3-year class for MACRS. Installation costs for the new machine are $7,000. The estimated salvage value of the new machine is $30,000. This new machine is more efficient than the existing one and thus savings before taxes using the new machine are $8,000 a year. 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 1?

MACRS Fixed Annual Expense Percentages by Recovery Class

3 Year MACRS percentages

Year 1= 33.33%

Year 2=44.45%

Year 3=14.81%

Year 4=7.41%

Answer 1

Calculation of incremental cash flow in year 1 for Project
Year	1
Pretax cost savings	$8,000.00
Tax on cost savings @ 30%	-$2,400.00
Depreciation Tax shield	$8,565.30
Incremental Cash flow in Year 1	$14,165.30
Working
Calculation of depreciation on new machine using 3-year class for MACRS rates
Year	Depreciable value	Depreciation Rates (3 year MACRS class)	Depreciation
1	$97,000.00	33.33%	$32,330.10
2	$97,000.00	44.45%	$43,116.50
3	$97,000.00	14.81%	$14,365.70
4	$97,000.00	7.41%	$7,187.70
Calculation of depreciation on old machine using 3-year class for MACRS rates
Year	Depreciable value	Depreciation Rates (3 year MACRS class)	Depreciation
-3	$51,000.00	33.33%	$16,998.30
-2	$51,000.00	44.45%	$22,669.50
-1	$51,000.00	14.81%	$7,553.10
1	$51,000.00	7.41%	$3,779.10
Calculation of tax shield on additional depreciation in Year 1
Depreciation on new machine	$32,330.10
Less : Depreciation on old machine	$3,779.10
Additional Depreciation	$28,551.00
Depreciation Tax Shield @ 30%	$8,565.30