Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: Cost of new machine $100,000
Annual cost savings in cash expenses 45,000
Terminal value 8,000
Maintenance required in the 4th year 5,000
Book value of the old machine 20,000
The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the terminal cash flows is:

Question

Quizplus · Accepted Answer

To calculate the present value of terminal cash flows, we use the formula:
PV(Terminal Cash Flows) = Terminal Value / (1 + Discount Rate)^n
where n = number of years from the end of the forecasting period to the terminal year

Here, the forecasting period is 5 years, and the terminal year is Year 5. So, n = 1.
Putting the values into the formula:
PV(Terminal Cash Flows) = 8,000 / (1 + 0.12)^1
PV(Terminal Cash Flows) = 8,000 / 1.12
PV(Terminal Cash Flows) = 7,142.86 (rounded off to the nearest dollar)

Therefore, the present value of the terminal cash flows is $7,143 (rounded off). None of the answer choices match this value exactly, but the closest one is B, which is $4,536.

Arnold Company Is Acquiring a New Machine with a Life