Rockyford Company must replace some machinery that has zero book value and a cur
ID: 2575875 • Letter: R
Question
Rockyford Company must replace some machinery that has zero book value and a current market value of $1,600. One possibility is to invest in new machinery costing $41,000. This new machinery would produce estimated annual pretax cash operating savings of $16,400. Assume the new machine will have a useful life of four years and depreciation of $10,250 each year for book and tax purposes. It will have no salvage value at the end of four years. The investment in this new machinery would require an additional $2,300 investment of net working capital. (Assume that when the old machine was purchased the incremental net working capital required at the time was $0.)
If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment will occur during the next four calendar years.
Determine the present value of the after-tax cash flows for the next four years attributable to the cash operating savings. (Round your answer to the nearest whole dollar amount.)
Which one of the following is the proper treatment for the additional $2,300 of net working capital required in the current year?
It should be included as part of the cost of the new machine and depreciated.
May I please receive a step-by-step walkthough for each problem.
Rockyford Company must replace some machinery that has zero book value and a current market value of $1,600. One possibility is to invest in new machinery costing $41,000. This new machinery would produce estimated annual pretax cash operating savings of $16,400. Assume the new machine will have a useful life of four years and depreciation of $10,250 each year for book and tax purposes. It will have no salvage value at the end of four years. The investment in this new machinery would require an additional $2,300 investment of net working capital. (Assume that when the old machine was purchased the incremental net working capital required at the time was $0.)
If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment will occur during the next four calendar years.
Rockyford is subject to a 40% income-tax rate for all ordinary income and capital gains and has a 11% weighted-average after-tax cost of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix C–Table 1 or Table 2.)Explanation / Answer
Requirement 4:
IF additional net working capital is required, it should be treated as part the initial investment when determining the net present value. This is because of the reason the net working capital is required as a investment i.e., in the current year and hence should be treated as part of investment.
Requirement 1: Determination of after tax cash flow arising from disposing of old machinery: Particulars Amount Market Value of Current machine 1600 Less: Book Value of current machine 0 Gain on disposal of old machinery 1600 Tax on Capital Gain 1600*40% 640 After tax cash flow from disposing old machinery 960 Requirement 2: Determination of present value of after tax cash flows attributable to cash operating savinga: Particulars Amount Annual Pretax cash operating savings 16400 Less: Taxes 16400*30% 4920 Annual post tax cash operating savings 11480 PVAF (11%, 4) 3.1024 PV of after tax cash flows 3.1024*11480 35615.552 Requirement 3: Determination of present value of tax shield effect of depreciation for year 1: Particulars Amount Depreciation 10250 Tax shield on depreciation 10250*30% 3075 PVIF (11%, 1) 0.9009 PV of tax shield effect of depreciation 0.9009*3075 2770.2675Related Questions
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