yea
Do these MACRS tables give you the amount taken for depreciation and the remaining percentage for book value?? From what I’ve seen on this thread: .15 ---->3 year MACRS depreciation rate provided on the thread .07----->???
3 year projection 3 year asset class Y3 MACRS = .15 Y4 MACRS = .07
wow this was a great question. So because this is a replacement project, we only look at the CHANGES in the CF followed by the terminal value of the last machine because we are looking at the year 3 which happens to be the same year that the new machine is sold. I’m assuming if the question asked for Year 2 CF then the terminal value of the new machine would not be counted and only the change in operating CF is calculated. Is this correct? In this example, we include the new machine terminal CF because its the same year as the machine will be sold, therefore: change in operating CF would be: (40-5)(1-0.35) + (100*0.15-0)(0.35) = 28 the “0” in the above is the salvage value of the old project which would be 0 in year 3 since its depreciation was zero by year 2. Terminal value of the new project is: Terminal CF= 20 - (20 - (100*0.07))(0.35) = 15.45 Therefore: Net CF = 28 + 15.45 = 43.45 Is this the correct reasoning? Sorry for the caps on top but I don’t see a bold/underline option.
*bump*
Alias, Inc. is a maker of plastic containers for the food and beverage industry. Bruce Atkinson, Alias’ director of operations, is looking at upgrading the firm’s manufacturing capacity in an effort to improve the firm’s competitive position. Atkinson is being assisted by Linda Ralston, a financial analyst recently hired by Alias. Over the last three months, Ralston and Atkinson have been going to trade shows and conducting other research on different machines and processes used in the plastic container industry. Ralston estimates that travel and hotel costs expended as a result of their research amounted to $8,000. Atkinson considers the money well spent because he now had two great ideas for improving Alias’ competitiveness in the industry. The first of these ideas is that Atkinson is considering replacing a bottle blow molding machine. This machine was purchased for $50,000 3 years ago and is being depreciated for tax purposes over 5 years to a zero salvage value using straight-line depreciation. The firm has 2 years of depreciation remaining on the old machine. If Atkinson decides to make the replacement, the old machine can be sold today for $10,000. The new machine will cost the firm $100,000. According to Ralston’s projections, the new machine will increase revenue by $40,000 per year for 3 years but will also increase costs by $5,000 per year. The machine will be depreciated over a modified accelerated cost recovery system (MACRS) 3-year class life. At the end of year 3, the equipment will be sold for $20,000. The firm’s tax rate is 35%. Atkinson is also considering an investment in a new silk screen labeling machine that can put labels on Alias plastic bottles as part of the manufacturing process. Ralston estimates that the new labeling machine will cost $50,000, and that shipping and installation costs will be $7,500. The addition of the labeling machine will require a $2,000 investment in spare parts inventory at the inception of the project, but these parts can be resold for $2,000 at the project’s end. Compared with the manual process that Alias used to use for putting on labels, Ralston estimates that the new machine will reduce costs by $25,000 per year for 4 years. The labeling machine will be depreciated over a MACRS 5-year class life. At the end of year 4, the equipment will be sold for $8,000. Depreciation schedules under MACRS are shown in the exhibit below: Ownership Year Class of Investment 3-Year 5-Year 7-Year 10-Year 1 33% 20% 14% 10% 2 45% 32% 25% 18% 3 15% 19% 17% 14% 4 7% 12% 13% 12% 5 11% 9% 9% 6 6% 9% 7% 7 9% 7% 8 4% 7% 9 7% 10 6% 11 3% 100% 100% 100% 100% Before making the final calculations, Atkinson and Ralston discuss net present value analysis for the projects they are considering. Ralston tells Atkinson, “when calculating the net present value of the two new projects, we also need to account for the costs expended as a result of researching the project options.” Atkinson makes a note on his legal pad and says to Ralston, “There is no need to make any adjustments for inflation in our net present value calculations because inflation is included as part of the expected returns used to calculate our weighted average cost of capital.” After their conversation, Ralston and Atkinson prepare their report to present to Alias’ CEO. The initial investment outlay for purchasing the new bottle blow molding machine is closest to: A) −$90,000. B) −$86,500. C) −$100,000. Your answer: B was correct! The initial outlay is the cost of the new machine minus the market value of the old machine plus/minus any tax consequences that arise from selling the old machine. The new machine’s cost is $100,000. The old machine can be sold for $10,000, however considering that the machine’s initial cost was $50,000 and has 3 years of accumulated straight-line depreciation, the book value of the old machine is $50,000 − (3 × 10,000) = $20,000. This means that the sale of the machine will result in a (10,000 − 20,000) = −10,000 loss. The loss will result in tax savings for Alias equal to 0.35 × 10,000 = $3,500. The total initial investment outlay for the new machine is: −$100,000 + 10,000 + 3,500 = −$86,500 (Study Session 8, LOS 28.a) -------------------------------------------------------------------------------- The year 1 operating cash flow for the new bottle blow molding machine is closest to: A) $30,800. B) $34,300. C) $22,750. Your answer: B was incorrect. The correct answer was A) $30,800. The operating cash flows equal the after-tax benefit plus the tax savings from depreciation. In the case of a replacement project, you must take the difference between the additional depreciation from the new asset minus the lost depreciation from the old asset. The firm gave up $10,000 per year for of depreciation on the old asset for years 1 and 2 of the new asset’s life. CF1 = (revenue − cost)1 × (1 − tax rate) + net depreciation1 × (tax rate) ((40,000 − 5,000) × 0.65) + [((0.33 × 100,000) − 10,000) × (0.35)] = $30,800 (Study Session 8, LOS 28.a) -------------------------------------------------------------------------------- The total cash flow from the bottle blow molding machine in year 3 is closest to: A) $43,450. B) $28,000. C) $48,000. Your answer: B was incorrect. The correct answer was A) $43,450. The total cash flow for the terminal year is equal to the operating cash flow plus the non-operating (or terminating) cash flow. The operating cash flow equals: CF3 = (revenue − cost)3 × (1 − tax rate) + net depreciation3 × (tax rate) ((40,000 – 5,000) × 0.65) + [((0.15 × 100,000) − 0) × 0.35)] = $28,000 The year 3 non-operating cash flow equals: Market or salvage value plus/minus tax consequences of selling it. The new machine will be sold for $20,000. The book value is: $100,000 × 0.07 = $7,000 $20,000 – $7,000 = $13,000 The firm will pay taxes on the gain of: 13,000 × 0.35 = $4,550 Total terminal year cash flow = $28,000 + $20,000 – $4,550 = $43,450 Note: Once we have the project’s estimated cash flows, the next step in the process would be to calculate the net present value and internal rate of return for the project. (Study Session 8, LOS 28.a) -------------------------------------------------------------------------------- The initial cash flow for the labeling machine is closest to: A) −$50,000. B) −$57,500. C) −$59,500. Your answer: C was correct! The initial outlay is the cost of the labeling machine, the shipping and installation costs, and the increase in net working capital (in this case the increase in spare parts inventory): (−$50,000) + (−$7,500) + (−$2,000) = −$59,500. (Study Session 8, LOS 28.a) -------------------------------------------------------------------------------- The year 2 operating cash flow for the labeling machine is closest to: A) $21,040. B) $34,650. C) $22,690. . The correct answer was C) $22,690. The operating cash flows equal the after-tax benefit plus the tax savings from depreciation. CF2 = Benefit2 × (1 − tax rate) + depreciation2 × (tax rate) ($25,000 × 0.65) + ($57,500 × 0.32 × 0.35) = $22,690 Note that the shipping and installation costs are part of the depreciable basis for the machine. (Study Session 8, LOS 28.a) -------------------------------------------------------------------------------- With regard to the conversation between Ralston and Atkinson concerning NPV analysis: A) Ralston’s statement is incorrect; Atkinson’s statement is correct. B) Ralston’s statement is correct; Atkinson’s statement is incorrect. C) Ralston’s statement is incorrect; Atkinson’s statement is incorrect. The correct answer was C) Ralston’s statement is incorrect; Atkinson’s statement is incorrect. The hotel and travel costs expended to research the projects would be expended whether Alias decided to take on the projects or not. The research costs are a sunk cost, which is a cash outflow that has previously been committed or has already occurred. Since these costs are not incremental, they should not be included as part of the analysis. Therefore Ralston’s statement is incorrect. Atkinson’s statement is also incorrect. Although it is true that the expected inflation is built into the expected returns used to calculate the weighted average cost of capital, Atkinson and Ralston still need to adjust the project cash flows upward to account for inflation. If no adjustments are made to the project cash flows to account for inflation, the NPV will be biased downward. (Study Session 8, LOS 28.g) Question ID 87117 just in case if formatting makes in unreadable.
Thank you very much boston, This makes it make a lot more sense 
np, bud.
Why is Operating Cash Flow for year 1 $30,800?
If revenue increases 35,000, shouldn’t we subtract the incremental depreciation charge from that before paying taxes?
So 35,000 – (0.33 x 100,000) + (10,000 x 0.35) = 5,500.
Then we pay tax (35%) on the $5,500 and we have $3,575. After this, we should add back the depreciation to get Cash Flow.
The tax shield (1 - 35%) is applied to the net amount of depreciation so you have to reduce the new machine’s depreciation $33,000 by $10,000 (annual depreciation from the old machine) to get $23,000.
CF = (S - C - D)(1 - T) + D
S = $40,000
C = $5,000
D = ($100,000 * 33%) - $10,000 = $23,000
T = 35%
CF = ($40,000 - $5,000 - $23,000)(1 - 0.35) + $23,000
= $30,800