What is the depreciation expense in Year 1 (in $s)? What is the depreciation exp

ID: 2792809 • Letter: W

Question

What is the depreciation expense in Year 1 (in $s)?

What is the depreciation expense in Year 2 (in $s)?

What is the book value of the equipment in year 2?

What is the after tax salvage value of the equipment at the end of year 2?

What is the terminal cash flow (the last cash flow of the project not including the OCF)?

Amazon is considering producing a new laptop. This will be a two year project. a. New equipment will cost $10,000,000 and depreciation is by the 3-year MACRS method. b. The project requires an initial investment in net working capital of $1,000,000 (which will be recaptured at the end of the project). c. Amazon paid $500,000 last year to conduct a market study to see the demand for an Amazon laptop. d. The new laptop will directly generate $6,000,000 in revenues each year of the project's life. e. In addition to the revenues in d., the new laptop will also increase existing Amazon App Store revenues by $500,000 each year of the project's life. f. In addition to the revenues in d., the new laptop will also decrease existing Kindle revenues by $1,000,000 each year of the project's life. g. The new project will have expenses of $1,000,000 each year of the project's life. h. There is no interest expense. i. At the conclusion of the project in two years, the equipment can be sold for $2,500,000. j. The firm's marginal tax rate is 25 percent, and the project's cost of capital is 7 percent.

Explanation / Answer

Initial investment 10,000,000 which will be depreciated using 3 years MACRS.

Thus the depreciation schedule is as below:

Depreciation Expense= 10000000 * MACRS

Ending Value = Beginning value - Ending Value

Year

Beginning Value

MACRS

Depreciation Expense

Ending Value

10000000

33.33%

3333000

6667000

44.44%

4444000

2223000

14.82%

1482000

741000

The depreciation expense in year 1 = 3333000
The depreciation expense in year 2 = 4444000
The book value of equipment in year 2 = 6667000

After tax salvage value = (Salvage-book value)*(1-tax)
=2500000-2223000 * 0.75
=207750

Terminal year cashflow = Salvage+WCinv - Tax*(salvage-bookvalue)
=2500000+1000000 - 0.25*(2500000-2223000)
=3500000 - 69250
=3430750