# Looner Industries is currently

Looner Industries is currently analyzing the purchase of a newmachine that costs \$165,000

and requires \$19,800in installation costs. Purchase of thismachine is expected to result in an increase in net working capitalof \$30,400to support the expanded level of operations. The firmplans to depreciate the machine under MACRS using a​ 5-yearrecovery period​ (see the table

LOADING…for the applicable depreciation​ percentages) andexpects to sell the machine to net

\$10,400 before taxes at the end of its usable life. The firm issubject to a 40 % tax rate.

 Rounded Depreciation Percentages by Recovery Year Using MACRSforFirst Four Property Classes Percentage by recovery year* Recovery year 3years 5years 7years 10 years 1 33% 20% 14% 10% 2 45% 32% 25% 18% 3 15% 19% 18% 14% 4 7% 12% 12% 12% 5 12% 9% 9% 6 5% 9% 8% 7 9% 7% 8 4% 6% 9 6% 10 6% 11 4% Totals 100% 100% 100% 100%

a. Calculate the terminal cash flow for a usable life of ​ (1)3​ years, (2) 5​ years, and​ (3) 7 years.

b. Discuss the effect of usable life on terminal cash flowsusing your findings in part a.

assuming a​ 5-year usable​ life, calculate the terminal cashflow if the machine were sold to net​ (1) \$9,240

or​ (2) \$170,500(before taxes) at the end of 5 years.

d. Discuss the effect of sale price on terminal cash flow usingyour findings in part c.

Firstly we will compute the total value of cost of machine asthe cost of machine includes the cost of installation.

 cost of New machine \$165000 Installation cost \$19,800 Total cost ofmachine \$184800

Step 1 :part a :Calculate the terminal cash flow for a usable life of ​ (1)3​ years, (2) 5​ years, and​ (3) 7 years

Expected selling price of machine:\$10,400(given)

Increase in working capital change :\$30,400(given)

Scrap value -nill(assumed)(so ignoring incomputation)

Terminal cash flow : salvage or scrap value +tax savingon loss of asset or ( -) Tax burden on gain on sale of asset+release of working capital.

 Particulars 3 years 5 years 7 years a)selling price \$10400 \$10400 \$10400 b)Book value of machine 184800 184800 184800 c)Cummulative depreciation charged onmachine (144144) (171864) (184800) d)remaining value(b-c) 40656 12936 – e)Profit /loss on sale(a-d) (30256) (2536) 10400 f)tax saving on sale of asset 12,102.4 1014.4 g) tax gain in sale of asset 4160 h)net working capital \$30,400 \$30,400 \$30,400 Terminal value \$42502.4 \$31414.4 \$26240

step 2 : partb:Discuss the effect of usablelife on terminal cash flows using your findings in part a.

From part a we can conclue the terminal value is more in year 3as compared to year 5 when the machine is sold in the less than theremaining book value.

Step 3 :partc:assuming a​ 5-year usable​ life,calculate the terminal cash flow if the machine were sold to net​(1) \$9,240or​ (2) \$170,500(before taxes) at the end of 5years

 Particulars 5 years 7 years a)selling price \$9400 \$170500 b)Book value of machine 184800 184800 c)Cummulative depreciation charged onmachine (171864) (184800) d)remaining value(b-c) 12936 – e)Profit /loss on sale(a-d) (3536) 170500 f)tax saving on sale of asset 1414.4 g) tax gain in sale of asset 68200 h)net working capital \$30,400 \$30,400 Terminal value \$31814.4 \$(68200)

step 4:partd:Discuss the effect of sale price on terminal cash flowusing your findings in part c.

As a result of high selling price in year 5 i.e 170500the 5th year ‘s terminal value is negative which means as a resultof increase in tax burdern there will be an outflow \$68200. whereasthe selling price of year 3 is lessthan the remaining book value asa result there is tax saving and the terminal cash flow ispositive.

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