Bulldog Inc. purchased a leather-cutting machine seven years ago. The cost of th
ID: 2794101 • Letter: B
Question
Bulldog Inc. purchased a leather-cutting machine seven years ago. The cost of the machine was $11,200. It was epected to be used for 10 years. The machine has been depreciated on a straight-line basis with an estimated salvage value of $1,200. The machine can be sold for $3,500 today.
Bulldog is considering the purchase of a new leather-cutting machine to replace exisiting machine. Having the new machine will result in an increase of revenue $13,000, but the operating costs will also increase by $6,000 for 3 years. The new machine cost $14,000, with an expected salvage of $2,000 at the end of the third year. The new machine will be depreciated using MACRS method, and is considered a 3-year property. There will be an increase of $1,600 in net working capital. Gorilla's tax rate is 40% and cost of capital is 16%.
A. compute the depreciation for the old machine and the new machine as well as the incremental depreciation for each of the new 3 years.
b. What is the book value of the old machine today? Answer is $4,200, how did I get this? Show work.
c. What is the tax consequence of the sale of the old machine today? Answer is : tax savings of $280, how did I get this? show work.
D. What is the after-tax selling price of the old machine? Answer is $3,780. How did I get this> show work'
e.. What is the net initial investment for the new machine? answer is -$11,820 How did I get this>show work
F. The expected after-tax salvage value of the new machine is $1,620. Compute the expected net cash flow at the end of year 3. (Note: You are asked to find CF3 only, not NPV) Answer is $7,848.80 How did I get this >show work
Explanation / Answer
Answer a.
The cost of old machinery is 11200 with salvage value of 1200 depreciated using SLM for 10 years
Thus depreciaton=11200-1200/10 = 10000/10 = 1000 per year
The new and incremental dpreciation are in bold in the excel below:
Year
Beginning value
MACRS
Depreciation = Initial investment ie 14000*MACRS
Ending Value = beginning value - depreciation
Incremental depreciation = Depreciation - old depreciation ie 1000
1
14000
33.33%
4666.20
9333.80
3666.20
2
9333.80
44.45%
6223.00
3110.80
5223.00
3
3110.80
14.81%
2073.40
1037.40
1073.40
Answer b. Old machine has been used for 7 years now and thus the total deprecition will be 7*1000 = 7000
But the value of the machine was 11200
thus book value = 11200-7000 = 4200
Answer c. The tax saving on old machine = Tax*(salvage-bookvalue)
salvage = 3500 as it is the current value at which the machine can be sold
thus = 0.4*(3500-4200)
=0.4*(-700)
=-280
as this is negative it means this is tax saving of $280
Answer d. After tax selling price of the old machine = Salvage+WCinv - Tax*(salvage-book value)
=3500+0 - 0.4*(3500-4200)
=3500 - (-280)
=3780
Answer e.
Given the new machine cost is $14000 ie FCinv = 14000 and working capital will increase by 1600 ie WCinv = 1600
Hence, Replacement net initial investment = FCinv + Wcinv - old salvage + Tax*(old salvage - old book value)
14000+1600 - 3500 + 0.4*(3500-4200)
= 12100 + 0.4(-700)
=12100 - 280
= 11820
Answer f. The expected after tax salvage value of new machine = 1620
And after tax operating cashflow = (change in revenue)*(1-tax)+change in depreciation
=(13000-6000)*(1-0.4)+1037.4
=5237.4
Year
Beginning value
MACRS
Depreciation = Initial investment ie 14000*MACRS
Ending Value = beginning value - depreciation
Incremental depreciation = Depreciation - old depreciation ie 1000
1
14000
33.33%
4666.20
9333.80
3666.20
2
9333.80
44.45%
6223.00
3110.80
5223.00
3
3110.80
14.81%
2073.40
1037.40
1073.40
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