The Weis Corp. purchased a new conveyor system to replace an older less automated system. The old system, which was 10 years old, was being depreciated on a straight-line basis over its 20-year life at $25,000 per year. The new system will be depreciated as a 7-year asset for MACRS purposes. The more efficient machine, which costs $520,000 installed, will reduce operating costs by $74,000 per year. Compute the net cash flows in year 3 for the new system. Assume a 40% tax rate. Use the rounded MACRS schedule listed below:
(7-Year Depreciation Schedule: 14%, 25%, 18%, 12%, 9%, 9%, 9%, 4%)
A) $71,840
B) $80,779
C) $68,600
D) $149,917

Question

The Weis Corp. purchased a new conveyor system to replace an older less automated system. The old system, which was 10 years old, was being depreciated on a straight-line basis over its 20-year life at $25,000 per year. The new system will be depreciated as a 7-year asset for MACRS purposes. The more efficient machine, which costs $520,000 installed, will reduce operating costs by $74,000 per year. Compute the net cash flows in year 3 for the new system. Assume a 40% tax rate. Use the rounded MACRS schedule listed below: 
(7-Year Depreciation Schedule: 14%, 25%, 18%, 12%, 9%, 9%, 9%, 4%)
A) $71,840
B) $80,779
C) $68,600
D) $149,917

Quizplus · Accepted Answer

1. Calculate the tax savings from depreciation:
- First 2 years: $520,000 x 14% + $520,000 x 25% = $182,000
- Year 3: $520,000 x 18% = $93,600
- Total tax savings from depreciation in year 3: $93,600 x 40% = $37,440

2. Calculate the net cash flow in year 3:
- Operating cost savings: $74,000
- Depreciation tax savings: $37,440
- Total cash inflow: $74,000 + $37,440 = $111,440

3. Calculate the depreciation expense in year 3:
- Using the MACRS schedule, the depreciation rate for year 3 is 18%
- Depreciation expense for year 3: $520,000 x 18% = $93,600

4. Calculate the tax liability:
- Taxable income: $74,000 - $93,600 = -$19,600
- Tax liability: $19,600 x 40% = $7,840

5. Calculate the net cash flow after tax:
- Net cash flow in year 3: $111,440 - $7,840 = $103,600

6. Calculate the cumulative depreciation:
- Cumulative depreciation after 3 years: $520,000 x (14% + 25% + 18%) = $273,600

7. Calculate the book value of the asset:
- Book value of the asset after 3 years: $520,000 - $273,600 = $246,400

Therefore, the net cash flow in year 3 for the new system is $71,840 (Option A).