Denver Auto Wash is contemplating the purchase of a new high-speed washer to rep

Question

Denver Auto Wash is contemplating the purchase of a new high-speed washer to replace the existing washer. The existing washer was purchased two years ago at an installed cost of $120,000; it was being depreciated under MACRS using 5-year recovery period. The existing washer is expected to have a usable life of five more years. The new washer costs $210,000 and requires $10,000 in installation costs; it has a 5-year usable life and would be depreciated under MACRS using 5-year recovery period. The existing washer can currently be sold for $140,000 without incurring any removal or cleanup costs. To support the increased business resulting from the purchase of the new washer, accounts receivable would increase by $80,000, inventories by $60,000, and accounts payable by $116,000, and these changes are recouped at the end of the project. At the end of five years, the existing washer is expected to have a market value of zero; the new washer would be sold to net $58,000 after removal and cleanup costs and before taxes. The firm pays taxes at a rate of 40% on both ordinary income and capital gains.

MACRS 5-year recovery schedule

Year

1

2

3

4

5

6

Percentage

20%

32

19

12

12

5

The estimated profits before depreciation and taxes over the five years for both the new and existing washer are shown as:

What is the second year incremental operating cash flow of this project?

Year

1

2

3

4

5

6

Percentage

20%

32

19

12

12

5

Explanation / Answer

Second year incremental operating cash flows: $ 45,200.

Incremental Depreciation :

Installed Cost of New Washer : $ 220,000.

Second year incremental profit before depreciation and taxes = $ ( 86,000 - 48,000) = $ 38,000

Second year incremental operating cash flows after taxes = $ 38,000 x 0.60 + $ 56,000 x 0.40 = $ 22,800 + $ 22,400 = $ 45,200.

Year 1 Year 2 Year 3 Year 4 Year 5 $ $ $ $ $ Depreciation ( New Washer) 44,000 70,400 41,800 26,400 26,400 Depreciation ( Old Washer) 22,800 14,400 14,400 6,000 0 Incremental Depreciation 21,200 56,000 27,400 20,400 26,400

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