You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $70,000. The truck falls into the MACRS 3-year class, and it will be sold after three years for $20,500. Use of the truck will require an increase in NWC (spare parts inventory) of $2,500. The truck will have no effect on revenues, but it is expected to save the firm $23,400 per year in before-tax operating costs, mainly labor. The firm’s marginal tax rate is 35 percent. What will the cash flows for this project be? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)

In order to get the answer we have to do 2 things, first, we need to construct a marginal profit statement and with that, we can find the final cash flow of this project.

Constructing the Marginal Profit statement.

Savings

We start by just adding from year 0 to 3 the savings, since it will save money to the company, it is clear that its earnings before taxes will increase too, so in our statement, all savings will add to the marginal profit. It should look like this.

Marginal Profit Statement

Item 0 Year 1 Year 2 Year 3 Year

Savings $23.400 $23.400 $23.400

Depreciation.

Under MACRS 3 year class depreciation, we need to find the annual depreciation for each year.

MACRS 3 yr depreciation

1 2 3 4

Item Amount 33,33% 44,45% 14,81% 7,41%

Cost $70.000

Annual Depreciation -23.331 -31.115 -10.367 -5.187

What this means is that in year 1 the truck´s depreciation is equivalent to 33.33% of the original cost of the truck, in year 2 it will be 44.45% and so forth.

Then we find the Marginal profit before taxes by subtracting the depreciation from the savings. From there, we calculate the taxes,which are 35% of the marginal profit before taxes, therefore obtaining out marginal profit.

Marginal Profit Statement

Item 0 Year 1 Year 2 Year 3 Year

Savings $23.400 $23.400 $23.400

Depreciation -$23.331 -$31.115 -$10.367

Marginal Profit before taxes $69 -$7.715 $13.033

Taxes -$24 $2.700 -$4.562

Marginal Profit $45 -$5.015 $8.471

From here we need to construct the cash flow of the project, which will begin with the Marginal profit and subsequently add the annual depreciation expenses for every year. It should look like this.

Cash Flow

Item 0 Year 1 Year 2 Year 3 Year

Marginal Profit $45 -$5.015 $8.471

(+) Depreciation $23.331 $31.115 $10.367

Gross Cash Flow $23.376 $26.100 $18.838

Now, to the next part, we need to subtract the initial investment (truck cost and its spare parts) which will go under year 0 and in year 3, since we are going to sell the truck for $20,500, and we will profit out of it, we have to pay taxes too. The way to find out how much we need to pay is by subtracting the accumulated depreciation from the amount that we are selling the truck. That results into the profit of this operation, that means that 35% of that profit is equivalent to the taxes that are required to pay for selling this asset. To this point, it should look like this.

Cash Flow

Item 0 Year 1 Year 2 Year 3 Year

Marginal Profit $45 -$5.015 $8.471

(+) Depreciation $23.331 $31.115 $10.367

Gross Cash Flow $23.376 $26.100 $18.838

Investment

(-)All P Truck -$70.000

(-)Spare Parts -2500

Sell Truck For $20.500

Book Value $5.187

Taxes -$5.360

Money Received $15.140

Final Cash Flow -$72.500,00 $23.420,70 $26.100,25 $33.978,90

In year 0 all we have is money outflows, therefore our cash flow is a - 72500, in years 1 and 2 the gross cash flow is the same as the final cash flow, but in year 3, we have to add the gross cash flow to the money received (not to the 20,500 we sold the truck for) in order to get that year´s cash flow.

please check out the attached excel spreadsheet for more details.

Best of luck,

topeadeniran2 topeadeniran2 · Answer 2 · 2022-04-18T00:13:14+02:00

The cash flow for the project for each year will be $-72500, $23375.85, and $26100.25.

How to compute the cash flow?

The cash flow for year 0 will be:

= -$70000 - $2500

= -$72500

The cash flow for year 1 will be:

= Cost saving × (1 - Tax rate) + Truck cost × MACRS + Tax rate

= $23400 × (1 - 35%) + $70000 × 33.33% × 35%

= $23375.85

The cash flow for year 2 will be:

= $23400 × (1 - 35%) + $70000 × 44.45% × 35%

= $26100.25

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