Jayco, Inc. is considering the purchase of a new machine for $60,000 that will reduce manufacturing costs by $5,000 annually.
- Jayco will use the 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. (The percentages for the 5-year MACRS class are, beginning with year 1 and ending with year 6, 20%, 32%, 19%, 12%, 11%, and 6%.)
- 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 6 years.
- Jayco’s marginal tax rate is 40%, and the firm uses a 12% cost of capital to evaluate projects of this nature.
What is the project’s terminal year after-tax non-operating cash flow?
A)
($9,000).
B)
($4,000).
C)
$21,000.
Explanation
Terminal cash flow = [salvage price] − (tax rate) × [salvage price − book value] ± reversal of change in working capital.
= 10,000 − (0.40) × (10,000 − 0) − 15,000 = 10,000 – 4,000 − 15,000 = −9,000.
If the problem says working capital will reduce due to purchasing the equipment, why do we not add the $15,000?