Question

Question

"A manufacturing firm is considering purchasing a new machine for $166,000. The firm plans on borrowing $83,000 to be paid off in equal payments in 3 years. The interest rate on the loan is 7.9%. The machine is classified as 7-years MACRS. Using the machine will save $40,000 in labor costs each year. The annual O&M costs for the machine are $9,000. The firm plans on using the machine for 5 years after which it will be salvaged for $74,700.
Calculate the taxable income (i.e., income before taxes) for the income statement for year 2 if the firm purchases the machine."

Answer 1

In year 2,

MACRS depreciation ($) = Cost** x 24.49% = 166,000 x 24.49% = 40,653.4

Loan repayment ($) = Loan amount / P/A(7.9%, 3) = 83,000 / 2.5818^# = 32,148.11

Therefore,

Taxable income ($) = Labor savings - O&M Cost - Annual depreciation - Loan repayment

= 40,000 - 9,000 - 40,653.4 - 32,148.11

= - 41,801.51

**MACRS ignores salvage value

#P/A(r%, N) = [1 - (1 + r)^-N] / r

P/A(7.9%, 3) = [1 - (1.079)^-3] / 0.079 = (1 - 0.7960) / 0.079 = 0.2040 / 0.079 = 2.5818