Capital Budgeting

I have two inquiries in the below question from schweser material;

Mayco, Inc. is considering the purchase of a new machine for $60,000. The machine will reduce manufacturing costs by $5,000 annually. Mayco will use the modified accelerated cost recovery system (MACRS) accelerated method (5-year asset) to depreciate the machine and expects to sell the machine at the end of its 6-year operating life for $10,000. Use the MACRS table in Figure 1. (Remember, you don’t have to memorize the MACRS tables!) The firm expects to be able to reduce net working capital by $15,000 when the machine is installed, but required working capital will return to the original level when the machine is sold after six years. Mayco’s marginal tax rate is 40%, and it uses a 12% cost of capital to evaluate projects of this nature.

The first year’s operating cash flow and terminal year’s cash flow excluding the last year’s operating cash flow are closest to: A. $4,800 OCF and –$4,000 CF. B. $7,800 OCF and –$4,000 CF. C. $7,800 OCF and –$9,000 CF. Year 1 operating cash flow = [net income impact × (1 – t)] + (depreciation × t) = ($5,000) (0.6) + ($60,000)(0.2)(0.4) = $7,800. Terminal year cash flow (excluding that year’s operating cash flow) = after-tax proceeds from sale of the new machine less working capital return = $10,000 – [($10,000)(0.4)] – $15,000 = –$9,000.


  1. How did we come up with the Net Income of $5,000? is it through (reduced 5000 in cost + reduced 15000 from working capital-depreciation in first year of 10000)

  2. When calculating operating cash flow, should not we add back all depreciation not only (depreciation × t)?