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.
Answer:
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.
"Our Prices Start at $11.99. As Our First Client, Use Coupon Code GET15 to claim 15% Discount This Month!!"
