Solved Question: The J. J. Hill Company is considering new digging equipment machine

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Question:

The J. J. Hill Company is considering new digging equipment machine. The existing digging equipment cost $1,000,000 five years ago and is being depreciated using MACRS, when classified as a 5-year asset. Hill’s management estimates the old equipment can be sold for $200,000. The new equipment costs $1,200,000 and would be depreciated over five years using MACRS. At the end of the fifth year, Hill’s management intends to sell the new equipment for $400,000. The new equipment is more efficient and would reduce expense by $200,000 per year for the next five years. The marginal tax rate is 35%.

(a) What are the cash flows related to the acquisition of the new equipment?

(b) What are the cash flows related to the disposition of the old equipment?

(c) What are the cash flows related to the disposition of the new equipment?

(d) What are the operating cash flows for each year?

(e) What the net cash flows for each year?

a) Cash outflow for acquisition of new machine = 1200000 Answer
b) Sale value of old machine 200000
Book Value of old machine = 1000000*5.76% (6th year depreciation) = 57600
Gain on sale 142400
Tax on gain = 142400*35% = 49840
NET AFTER TAX CASH INFLOW ON SALE OF OLD MACHINE = 200000-49840 = 150160 Answer
c) Sale value of the new machine at t5 400000
Book value at t5 = 1200000*5.76% = 69120
Gain on sale 330880
Tax on gain = 330880*35% = 115808
NET AFTER TAX CASH INFLOW ON SALE OF NEW MACHINE = 400000-115808 = 284192 Answer
d) 0 1 2 3 4 5
Before tax savings in expense 200000 200000 200000 200000 200000
Depreciation (MACRS 5 Year) 240000 384000 230400 138240 138240
Net savings before tax -40000 -184000 -30400 61760 61760
Tax at 35% -14000 -64400 -10640 21616 21616
Net savings after tax -26000 -119600 -19760 40144 40144
Add: Depreciation 240000 384000 230400 138240 138240
Annual OCF 214000 264400 210640 178384 178384
e) Capital expenditure 1049840 -284192
Net cash flows for each year -1049840 214000 264400 210640 178384 462576

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