PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, wh
ID: 2820247 • Letter: P
Question
PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $110 million on equipment with an assumed life of 5 years and an assumed salvage value of $10 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $80 million. A new modem pool can be installed today for $150 million. This will have a 3-year life and will be depreciated to zero using straight-line depreciation. The new equipment will enable the firm to increase sales by $25 million per year and decrease operating costs by $10 million per year. At the end of 0 years, the new equipment will be worthless. Assume the firm's tax rate is 35% and the discount rate for projects of this sort is 10%. a. What is the net cash flow at time 0 if the old equipment is replaced? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) Net cash flow millionExplanation / Answer
1)Depreciation for old equipment = [cost-salvage value ]/useful life
= [110 - 10]/5
= 20
Depreciation for 2 years = 20*2 =40
Book value at time of replacement = cost- Accumulated depreciation
= 110 -40
= 70
Gain on sale of old equipment= sale value -book value
= 80 -70
= 10
Tax on gain = 10*.35= 3.5
After tax cash flow from sale of old equipment = 80- 3.5= 76.50 (cash inflow from sale)
cash outflow (purchase cost ) = 150
Cash flow in year 0 = cash inflow -cash outflow
= 76.5-150
= - 73.50 million
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