Question

Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3 year tax life and would be fully depreciated by the MACRS method over 3 years, but it would have a positive pre-tax salvage value at the end of year 3, when the project would be closed down. Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3 year life. What is the project's total cash flow in year 3? Create a table. DO NOT USE EXCEL

-Net investment in fixed assests = $70,000

- Required net opertaing work capital = $15,000

-Depreciation (MACRS): 33% in year 1

45% in year 2

15% in year 3

7% in year 4

- Earnings before taxes & depreciation = $54,000

- Expected pre-tax salvage value = $6,000

- Tax Rate: 35%

- WACC: 8%

Answer 1

Time line		0		3
Cost of new machine		-70000
Initial working capital		-15000
=Initial Investment outlay		-85000
3 years MACR rate				15.00%	7.00%
Profits				54000
-Depreciation	=Cost of machine*MACR%			-10500	4900	=Equipment cost*(1-0.33-0.45-0.15)=Salvage Value
=Pretax cash flows				43500
-taxes	=(Pretax cash flows)*(1-tax)			28275
+Depreciation				10500
=after tax operating cash flow				38775
reversal of working capital				15000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)			3900
+Tax shield on salvage book value	=Salvage value * tax rate			1715
=Terminal year after tax cash flows				20615