Principles of Managerial Finance

(Dana P.) #1
CHAPTER 8 Capital Budgeting Cash Flows 387

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costs. The total cost for 10 new buses is $3,000,000. Like the older buses, the
new ones would be depreciated using MACRS and a 5-year recovery period.
Scenic is taxed at a rate of 40% on ordinary income and capital gains. The fol-
lowing table presents revenues and cash expenses for the proposed purchase as
well as the present fleet. Use all of the information given to calculate operating
cash inflows for the proposed and present buses.

8–20 Terminal cash flow—Various lives and sale prices Looner Industries is cur-
rently analyzing the purchase of a new machine that costs $160,000 and requires
$20,000 in installation costs. Purchase of this machine is expected to result in an
increase in net working capital of $30,000 to support the expanded level of
operations. The firm plans to depreciate the machine under MACRS using a
5-year recovery period (see Table 3.2 on page 100 for the applicable deprecia-
tion percentages) and expects to sell the machine to net $10,000 before taxes at
the end of its usable life. The firm is subject to a 40% tax rate on both ordinary
and capital gains income.
a. Calculate the terminal cash flow for a usable life of (1) 3 years, (2) 5 years,
and (3) 7 years.
b. Discuss the effect of usable life on terminal cash flows using your findings in
part a.
c. Assuming a 5-year usable life, calculate the terminal cash flow if the machine
were sold to net (1) $9,000 or (2) $170,000 (before taxes) at the end of 5 years.
d. Discuss the effect of sale price on terminal cash flow using your findings in
part c.

8–21 Terminal cash flow—Replacement decision Russell Industries is considering
replacing a fully depreciated machine that has a remaining useful life of 10 years
with a newer, more sophisticated machine. The new machine will cost $200,000
and will require $30,000 in installation costs. It will be depreciated under
MACRS using a 5-year recovery period (see Table 3.2 on page 100 for the
applicable depreciation percentages). A $25,000 increase in net working capital
will be required to support the new machine. The firm’s managers plans to eval-
uate the potential replacement over a 4-year period. They estimate that the old
machine could be sold at the end of 4 years to net $15,000 before taxes; the new
machine at the end of 4 years will be worth $75,000 before taxes. Calculate the
terminal cash flow at the end of year 4 that is relevant to the proposed purchase
of the new machine. The firm is subject to a 40% tax rate on both ordinary and
capital gains income.

Year
123 456

With the proposed new buses
Revenue $1,850,000 $1,850,000 $1,830,000 $1,825,000 $1,815,000 $1,800,000
Expenses (excl. depreciation) 460,000 460,000 468,000 472,000 485,000 500,000


With the present buses
Revenue $1,800,000 $1,800,000 $1,790,000 $1,785,000 $1,775,000 $1,750,000
Expenses (excl. depreciation) 500,000 510,000 520,000 520,000 530,000 535,000

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