Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The origi

Question

Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $47,000; it is now five years old, and it has a current market value of $21,000. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $23,500 and an annual depreciation expense of $4,700. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $3,200 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 30 percent tax rate.

What will the cash flows for this project be? (Note that the $47,000 cost of the old oven is depreciated over ten years at $4,700 per year. The half-year convention is not used for the old oven. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places.)

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Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $47,000; it is now five years old, and it has a current market value of $21,000. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $23,500 and an annual depreciation expense of $4,700. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $27,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $3,200 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 30 percent tax rate.

Explanation / Answer

Calculation of Cash Flows:

0 1 2 3 4 5 6 Cost of New Oven 27,000 Less: Sale of Old Oven (21,000) Cash Outflow 6,000 Cash Inflow 3,200 3,200 3,200 3,200 3,200 3,200 Less: Depreciation 5,400 8,640 5,184 3,110.40 3,110.40 1,555.20 Cash Flow before Tax -2,200 -5,440 -1,984 89.60 89.60 1,644.80 Less: tax 0 0 0 26.88 26.88 493.44 Add: Depreciation 5,400 8,640 5,184 3,110.40 3,110.40 1.555.20 Cash Inflow 3,200 3,200 3,200 3,173.12 3,173.12 2,706.56 DF(10%) 0.909 0.826 0.751 0.683 0.621 0.564 Discounted Cash Inflow 2,908.80 2,643.20 2,403.20 2,167.24 1,970.50 1,526.50

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