Your company is considering the purchase of a new machine. The original cost of the old machine was $75,000; it is now five years old, and it has a current market value of $35,000. The old machine 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 $37,500 and an annual depreciation expense of $7,500. The old machine 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 machine whose cost is $80,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $15,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life, and the cost of capital is 15 percent. Assume a 40 percent tax rate. What will the year 1 operating cash flow for this project be?

Question

Quizplus · Accepted Answer

The year 1 operating cash flow is calculated as follows: Operating cash flow = (Cash savings - Tax on savings) + Depreciation tax shield. Cash savings = $15,000. Tax on savings = $15,000 * 40% = $6,000. Depreciation tax shield = Depreciation * Tax rate. Year 1 MACRS depreciation for a 5-year property is 20% of $80,000 = $16,000. Depreciation tax shield = $16,000 * 40% = $6,400. Operating cash flow = ($15,000 - $6,000) + $6,400 = $12,400.

Your Company Is Considering the Purchase of a New Machine