A Drlling machine costs S60,000, falling into the MACRS 3-year class. Its purcha
ID: 2791967 • Letter: A
Question
A Drlling machine costs S60,000, falling into the MACRS 3-year class. Its purchase would require an increase in net operating working capital of S5,000 at t-0. The machine would increase the firm's revenues by $30,000 per year but would also increase operating costs by $8,000 per year. It will be sold for $20,000 at the end of year 3 . The firm's tax rate is 35%. Questions: What is the net investment required at t = 0? What is the operating cash flow in Year 2? What is the terminal year non-operating cash flows at the end of Year 3?Explanation / Answer
1-
Net investment required at 0
year
cost of machine
MACRS rate
annual depreciation
cost of machine
60000
1
60000
33.33%
19998
plus investment in working capital
5000
2
60000
44.45%
26670
initial investment
65000
3
60000
14.81%
8886
Accumulated depreciation upto 3 years
55554
operating cash flow at year 0
Book value of machine
60000-55554
4446
sale value of machine
20000
gain on sale of machine
20000-4446
15554
tax on gain on sale of machine
15554*35%
5444
net sale proceed after tax
20000-5444
14556
2-
Year
increased revenue = additional revenue - additional operating cost
less annual depreciation
net revenue after depreciation
less tax 35%
after tax net revenue
add depreciation
net operating cash flow
2
22000
26670
-4670
-1634.5
-3035.5
26670
23634.5
3-
non terminal cash flow at year 3
salvage value
14556
recovery of working capital
5000
non terminal cash flow at year 3
19556
1-
Net investment required at 0
year
cost of machine
MACRS rate
annual depreciation
cost of machine
60000
1
60000
33.33%
19998
plus investment in working capital
5000
2
60000
44.45%
26670
initial investment
65000
3
60000
14.81%
8886
Accumulated depreciation upto 3 years
55554
operating cash flow at year 0
Book value of machine
60000-55554
4446
sale value of machine
20000
gain on sale of machine
20000-4446
15554
tax on gain on sale of machine
15554*35%
5444
net sale proceed after tax
20000-5444
14556
2-
Year
increased revenue = additional revenue - additional operating cost
less annual depreciation
net revenue after depreciation
less tax 35%
after tax net revenue
add depreciation
net operating cash flow
2
22000
26670
-4670
-1634.5
-3035.5
26670
23634.5
3-
non terminal cash flow at year 3
salvage value
14556
recovery of working capital
5000
non terminal cash flow at year 3
19556
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