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 cash flows for year 4 is:

Question

Quizplus · Accepted Answer

To calculate the present value of the cash flows for year 4, we need to calculate the net cash flows in that year and discount it back to present value using the given discount rate.

The net cash flow in year 4 is calculated as follows:

Annual cost savings in cash expenses: $45,000 
Less: Maintenance expense: $5,000 
Plus: Terminal value: $8,000 
Tax savings from depreciation expense: ($100,000 - $20,000)/5 * 30% = $12,000

Net cash flow in year 4 = $45,000 - $5,000 + $8,000 + $12,000 = $60,000

Discounting this back to present value using the given discount rate, we get:

Present value of cash flow in year 4 = $60,000/(1.12)^4 = $28,950.54 ≈ $28,951

Therefore, the answer is B.

Arnold Company Is Acquiring a New Machine with a Life