Parker Chemicals purchased a hexene extractor 10 years ago for $120,000. It is being depreciated on a straight-line basis over 15 years to an estimated salvage value of zero. It can be sold today for $10,000. Parker is considering purchasing a new more efficient extractor that would cost $270,000 installed and would be depreciated as a 10-year MACRS asset. (The depreciation rate for year one is 10 percent for this asset.) The company's marginal tax rate is 40%. If the new extractor is purchased, annual revenues will increase by $10,000 and annual operating expenses will decrease by $10,000. What is the net cash flow in year 1?

Question

Quizplus · Accepted Answer

To calculate the net cash flow in year 1, we need to consider several factors:1. **Depreciation of the old extractor**: The old extractor was purchased for $120,000 and is being depreciated over 15 years, which means an annual depreciation of $120,000 / 15 = $8,000. However, since it's being sold, we don't consider its depreciation for year 1 of the new extractor.2. **Sale of the old extractor**: Selling the old extractor for $10,000 generates cash but also a tax implication. Since its book value is $120,000 - (10 years * $8,000) = $40,000 and it's sold for $10,000, there's a loss of $30,000. This loss reduces taxable income, saving taxes of $30,000 * 40% = $12,000.3. **Depreciation of the new extractor**: The new extractor, costing $270,000, is depreciated using MACRS at 10% for the first year, which is $27,000. This depreciation reduces taxable income, saving taxes of $27,000 * 40% = $10,800.4. **Increased revenues and decreased expenses**: The increase in revenues and decrease in expenses total $20,000. This increases taxable income, resulting in additional taxes of $20,000 * 40% = $8,000.5. **Net cash flow calculation**: The net cash flow in year 1 is the sum of the cash from selling the old extractor, the tax savings from the loss on the sale, the tax savings from depreciation of the new extractor, and the net increase in after-tax income from operations, minus the additional taxes paid on the increased income.$$ \text{Net Cash Flow} = \$10,000 + \$12,000 + \$10,800 - \$8,000 = \$24,800 $$However, we must also subtract the cost of the new extractor, which is a cash outflow. Since the cost of the new extractor ($270,000) is not directly subtracted in year 1 due to it being capitalized and depreciated, the initial calculation overlooks this immediate cash outflow, which is not part of the net cash flow calculation for year 1 as it's considered an investment rather than an expense. Therefore, the correct calculation focuses on the operational cash flows and tax impacts:$$ \text{Net Cash Flow} = \$10,000 + \$12,000 + \$10,800 - \$8,000 = \$24,800 $$Given the options provided, it seems there might have been a misunderstanding in the calculation process, especially regarding the treatment of the new extractor's cost and the calculation of tax savings or additional tax due to operational changes. The correct answer should reflect the operational cash flows, including the sale of the old extractor, tax savings from the sale and depreciation, and the net operational income increase after taxes. Given the options and the calculations provided, none directly match the expected outcome based on the detailed calculation steps, suggesting a reevaluation of the calculation might be necessary. The closest option based on the operational cash flows and tax impacts would be:$$ \text{Net Cash Flow} = \$10,000 + \$12,000 + \$10,800 - \$8,000 $$However, this calculation does not match any of the provided options exactly, indicating a potential error in the initial calculation or a misunderstanding of the question's requirements. The correct approach involves considering the sale of the old asset, the tax implications of that sale, the depreciation benefits of the new asset, and the operational income changes, without subtracting the cost of the new asset directly from the first year's cash flow as it's an investment outlay, not an expense.

Parker Chemicals Purchased a Hexene Extractor 10 Years Ago for $120,000