Adler is replacing its old packing line with a more efficient line. The old line was being depreciated on a straight-line basis at a rate of $20,000 per year. The old machine has a current book value of $100,000. The new line, which costs $910,000, will be depreciated on a 10-year MACRS schedule. The more efficient operation is expected to increase revenues by $50,000 per year and reduce annual operating costs by $80,000. Compute the net cash flows for Adler in year 2. Assume Adler has a marginal tax rate of 40%. Use the rounded MACRS schedule listed below:
(10-Year Depreciation Schedule: 10%, 18%, 14%, 12%, 9%, 7%, 7%, 7%, 7%, 6%, 3%)

Question

Adler is replacing its old packing line with a more efficient line. The old line was being depreciated on a straight-line basis at a rate of $20,000 per year. The old machine has a current book value of $100,000. The new line, which costs $910,000, will be depreciated on a 10-year MACRS schedule. The more efficient operation is expected to increase revenues by $50,000 per year and reduce annual operating costs by $80,000. Compute the net cash flows for Adler in year 2. Assume Adler has a marginal tax rate of 40%. Use the rounded MACRS schedule listed below: 
(10-Year Depreciation Schedule: 10%, 18%, 14%, 12%, 9%, 7%, 7%, 7%, 7%, 6%, 3%)

Quizplus · Accepted Answer

First, we need to calculate the depreciation for year 2 using the MACRS schedule. According to the schedule, the depreciation for year 1 is 18%, so the depreciation for year 2 is 14%.

Depreciation for year 2 = $910,000 x 14% = $127,400

Next, we need to calculate the total tax savings from the depreciation.

Tax savings from depreciation = Depreciation x Marginal tax rate = $127,400 x 40% = $50,960

Now we can calculate the net cash flows for Adler in year 2.

Net cash flows = Increase in revenue - Decrease in operating costs - Tax savings from depreciation

Net cash flows = $50,000 - $80,000 - $50,960

Net cash flows = -$80,960

This means that Adler will have a net outflow of cash in year 2, which is not a desirable outcome. However, we need to add back the tax savings from depreciation to get the after-tax net cash flows.

After-tax net cash flows = Net cash flows + Tax savings from depreciation

After-tax net cash flows = -$80,960 + $50,960

After-tax net cash flows = -$30,000

This result means that Adler will still have a net outflow of cash in year 2, but it will be reduced by the tax savings from depreciation. The correct answer is B, as it represents the after-tax net cash flows for Adler in year 2.

Adler Is Replacing Its Old Packing Line with a More