380 PART 3 Long-Term Investment Decisions
LG4 LG5 LG6LG1ordinary income and capital gains. (Table 3.2 on page 100 contains the applica-
ble MACRS depreciation percentages.)
a. Calculate the book value of the old piece of equipment.
b. Determine the taxes, if any, attributable to the sale of the old equipment.
c. Find the initial investment associated with the proposed equipment
replacement.ST 8–2 Determining relevant cash flows A machine currently in use was originally pur-
chased 2 years ago for $40,000. The machine is being depreciated under
MACRS using a 5-year recovery period; it has 3 years of usable life remaining.
The current machine can be sold today to net $42,000 after removal and
cleanup costs. A new machine, using a 3-year MACRS recovery period, can be
purchased at a price of $140,000. It requires $10,000 to install and has a 3-year
usable life. If the new machine is acquired, the investment in accounts receivable
will be expected to rise by $10,000, the inventory investment will increase by
$25,000, and accounts payable will increase by $15,000. Profits before depreci-
ation and taxesare expected to be $70,000 for each of the next 3 years with the
old machine and to be $120,000 in the first year and $130,000 in the second
and third years with the new machine. At the end of 3 years, the market value of
the old machine will equal zero, but the new machine could be sold to net
$35,000 before taxes. Both ordinary corporate income and capital gains are sub-
ject to a 40% tax. (Table 3.2 on page 100 contains the applicable MACRS
depreciation percentages.)
a. Determine the initial investment associated with the proposed replacement
decision.
b. Calculate the incremental operating cash inflows for years 1 to 4 associated
with the proposed replacement. (Note:Only depreciation cash flows must be
considered in year 4.)
c. Calculate the terminal cash flow associated with the proposed replacement
decision. (Note:This is at the end of year 3.)
d. Depict on a time line the relevant cash flows found in parts a, b,and cthat
are associated with the proposed replacement decision, assuming that it is ter-
minated at the end of year 3.PROBLEMS
8–1 Classification of expenditures Given the following list of outlays, indicate
whether each is normally considered a capitalor an operatingexpenditure.
Explain your answers.
a. An initial lease payment of $5,000 for electronic point-of-sale cash register
systems.
b. An outlay of $20,000 to purchase patent rights from an inventor.
c. An outlay of $80,000 for a major research and development program.
d. An $80,000 investment in a portfolio of marketable securities.
e. A $300 outlay for an office machine.
f. An outlay of $2,000 for a new machine tool.
g. An outlay of $240,000 for a new building.
h. An outlay of $1,000 for a marketing research report.