Question

Mars Inc. is considering the purchase of a new machine that costs $60,000. This machine will reduce manufacturing costs by $5,000 annually. Mars will use the MACRS accelerated method (shown below) to depreciate the machine, and it expects to sell the machine at the end of its 5-year life for $10,000. The firm expects to be able to reduce net operating working capital by $15,000 when the machine is installed, but the net working capital will return to the original level when the project is over (i.e., after 5 years). Mars's marginal tax rate is 40 percent, and it uses a 12 percent cost of capital to evaluate projects of this nature.

Year	MACRS Percentage
1	0.20
2	0.32
3	0.19
4	0.12
5	0.11
6	0.06

Calculate the net cash flows of the project. Be sure to put the cash flows in the order below i.e., CF0 in box 1, CF1 in box 2, CF2 in box 3, etc. Cash outflows should be negative numbers, e.g., -23,500.

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Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-60000
Initial working capital		15000
=Initial Investment outlay		-45000
5 years MACR rate			20.00%	32.00%	19.00%	12.00%	11.00%
Savings			5000	5000	5000	5000	5000
-Depreciation	=Cost of machine*MACR%		-12000	-19200	-11400	-7200	-6600
=Pretax cash flows			-7000	-14200	-6400	-2200	-1600
-taxes	=(Pretax cash flows)*(1-tax)		-4200	-8520	-3840	-1320	-960
+Depreciation			12000	19200	11400	7200	6600
=after tax operating cash flow			7800	10680	7560	5880	5640
reversal of working capital							-15000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						6000
+Tax shield on salvage book value	=Salvage value * tax rate						1440
=Terminal year after tax cash flows							-7560
Total Cash flow for the period		-45000	7800	10680	7560	5880	-1920