Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The origi
ID: 2824765 • Letter: M
Question
Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $47,000; it is now five years old, and it has a current market value of $22,000. The old oven is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $23,500 and an annual depreciation expense of $4,700. The old oven can be used for six more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose cost is $26,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven are $2,900 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 35 percent tax rate. What will the cash flows for this project be? (Note that the $47,000 cost of the old oven is depreciated over ten years at $4,700 per year. The half-year convention is not used for the old oven. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places.) Year 0 1 2 3 4 5 6 FCF $ $ $ $ $ $ $
Explanation / Answer
Book value of old Oven after 5 Years
23500
Year
Cost of new equipment
Macrs rate
Annual depreciation
Depreciation on old Oven
incremental depreciation
selling price of old Oven
22000
1
26000
20%
5200
4700
500
loss on sale of old oven
-1500
2
26000
32%
8320
4700
3620
tax benefit on loss on sale of old oven
1500*35%
525
3
26000
19.20%
4992
4700
292
total benefit from sale of old oven
22000+525
22525
4
26000
11.52%
2995.2
4700
-1704.8
5
26000
11.52%
2995.2
4700
-1704.8
cost of new oven
26000
total depreciation charged on new oven
24502.4
less total benefits from sale of old equipment
22525
net cash outflow
3475
Year
0
1.00%
2
3
4
5
cash outflow
-3475
tax benefit on disposal of of new oven
(26000-24502.4)*35%
524.16
before tax cash savings
2900
2900
2900
2900
2900
less incremental depreciation
500
3620
292
-1704.8
-1704.8
before tax after depreciation cash savings
2400
-720
2608
4604.8
4604.8
after tax cash savings
1560
-468
1695.2
2993.12
2993.12
add incremental depreciation
500
3620
292
-1704.8
-1704.8
tax benefit on disposal of new oven
524.16
net operating cash flow
-3475
2060
3152
1987.2
1288.32
1812.48
Book value of old Oven after 5 Years
23500
Year
Cost of new equipment
Macrs rate
Annual depreciation
Depreciation on old Oven
incremental depreciation
selling price of old Oven
22000
1
26000
20%
5200
4700
500
loss on sale of old oven
-1500
2
26000
32%
8320
4700
3620
tax benefit on loss on sale of old oven
1500*35%
525
3
26000
19.20%
4992
4700
292
total benefit from sale of old oven
22000+525
22525
4
26000
11.52%
2995.2
4700
-1704.8
5
26000
11.52%
2995.2
4700
-1704.8
cost of new oven
26000
total depreciation charged on new oven
24502.4
less total benefits from sale of old equipment
22525
net cash outflow
3475
Year
0
1.00%
2
3
4
5
cash outflow
-3475
tax benefit on disposal of of new oven
(26000-24502.4)*35%
524.16
before tax cash savings
2900
2900
2900
2900
2900
less incremental depreciation
500
3620
292
-1704.8
-1704.8
before tax after depreciation cash savings
2400
-720
2608
4604.8
4604.8
after tax cash savings
1560
-468
1695.2
2993.12
2993.12
add incremental depreciation
500
3620
292
-1704.8
-1704.8
tax benefit on disposal of new oven
524.16
net operating cash flow
-3475
2060
3152
1987.2
1288.32
1812.48
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