Gizmo Inc has outstanding 30-year bonds with an 8% coupon rate, annual payments
ID: 2781322 • Letter: G
Question
Gizmo Inc has outstanding 30-year bonds with an 8% coupon rate, annual payments selling for $1,150. Its preferred stock is selling for $75 and pays a fixed dividend of $7.5. Gizmo Inc. common stock is selling for $100 and has a beta of 2. The last dividend paid was $10 and dividends are expected to grow at 10% a year. The target Capital structure calls for 30% debt, 10% Preferred Stock, and 60% Common Equity.
Gizmo Inc. is considering the purchase of a new machine to replace an old one. The original cost of the old machine was $50,000; it is now 1 year old and has a market value of $33,500. It is being depreciated using the MACRS 3-year class life and can be used for three more years at which time it will be worthless. The cost of the replacement machine is $100,000, has a useful life of 3 years, and an estimated market value of $14,000 at the end of three years. Sales are expected to increase by $75,000 per year. The new machine will be depreciated using the MACRS 3-year class life.
What is the change in depreciation for year 1,2,3? and What is the after-tax cash flow from the sale of the new machine at the end of the third year?
Explanation / Answer
Answer to 1
depreciation on old machine
Year
2
50000
44.45%
22225
3
50000
14.81%
7405
4
50000
7.41%
3705
depreciation on new machine
Year
1
100000
33.33%
33330
2
100000
44.45%
44450
3
100000
14.81%
14810
4
100000
7.41%
7410
differential depreciation
Year
depreciation on old machine
depreciation on new machine
incremental depreciation for the year
1
22225
33330
11105
2
7405
44450
37045
3
3705
14810
11105
answer to 2
Book value of machine
100000
total accumulated depreciation
92590
book value of machine after 3 years
7410
sale value of machine
14000
gain on sale of machine
14000-7410
6590
tax rate not given so before tax cash flow would be after tax cash flow which is 14000
Answer to 1
depreciation on old machine
Year
2
50000
44.45%
22225
3
50000
14.81%
7405
4
50000
7.41%
3705
depreciation on new machine
Year
1
100000
33.33%
33330
2
100000
44.45%
44450
3
100000
14.81%
14810
4
100000
7.41%
7410
differential depreciation
Year
depreciation on old machine
depreciation on new machine
incremental depreciation for the year
1
22225
33330
11105
2
7405
44450
37045
3
3705
14810
11105
answer to 2
Book value of machine
100000
total accumulated depreciation
92590
book value of machine after 3 years
7410
sale value of machine
14000
gain on sale of machine
14000-7410
6590
tax rate not given so before tax cash flow would be after tax cash flow which is 14000
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