XYZ would like to purchase a new machine. It will cost $50,000. Shipping and ins
ID: 2784529 • Letter: X
Question
XYZ would like to purchase a new machine. It will cost $50,000. Shipping and installation charges for the equipment are expected to total $5,000. This equipment will be depreciated using straight line for its 5 year economic life to an estimated salvage value of zero. In order to use this equipment, XYZ estimates it will have to add $7,000 initially to its net working capital. If the machine is purchased, it will replace a machine with a book value of $10,000, the old machine can be sold for $25,000. During the first year of operations, the company expects total revenues to increase by $50,000, and from years 2 to 5 increase by $60,000 per year. The incremental operating expense is expected to be $10,000 in the first year and increase each year by 5%. The marginal tax rate is 40%. Find year one net cash flow.
Explanation / Answer
Book Value of old machine = $10,000
Sale value = $25,000
After tax net proceed from sale = $10,000 + ($25,000 - $10,000) × (1 - 40%)
= $10,000 + $9,000
= $19,000
Net proceed from sale of old machine is $19,000.
Total Initial Cost = $50,000 + $5,000
= $55,000
Project Life = 5 year
Annal Depreciation = $55,000 / 5
= $11,000
Profit before tax in year 1 = $50,000 - $10,000 - $11,000
= $29,000
Profit before tax is $29,000.
Net profit in year 1 = $29,000 × (1 - 40%)
= $17,400
Net profit in year 1 is $17,400.
Net cash flow in year 1 = $17,400 + $11,000
= $28,400
Net cash flow in year 1 is $28,400.
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