Question

Ripstart is replacing an old, fully depreciated stamping line with a more efficient machine that will cost $400,000. The line will be depreciated as a 7-year MACRS asset. With the increased production, Ripstart expects revenues to increase by $85,000 each year, and operating expenses to decrease by $10,000 per year. If Ripstart expects to sell the new machine at the end of year 5 for $95,000, compute the net cash flow in the fifth year. The MACRS depreciation rate during the fifth year is 8.93% and the accumulated MACRS depreciation after five years totals 77.69 percent of the cost of the asset. Assume the firm’s marginal tax rate is 33 percent and that company does get to take the full benefit of year 5 depreciation

Answer 1

Answer: Net cash flow in the fifth year : $ 168,537

Annual earnings before interest, taxes, depreciation and amortization ( EBITDA) = Increase in revenues + decrease in operating expenses = $ 85,000 + $ 10,000 = $ 95,000

Depreciation in the 5th year = $ 400,000 x 8.93 % = $ 35,720

Operating cash flows after taxes in the 5th year = EBITDA ( 1 - t ) + Depreciation x t = $ 95,000 x ( 1 - 0.33 ) + $ 35,720 x 0.33 = $ 63,650 + $ 11,787.60 = $ 75,437.60.................(1)

Accumulated depreciation at the end of Year 5 = $ 400,000 x 77.69 % = $ 310,760

Book value at the end of 5th year = $ 400,000 - $ 310,760 = $ 89,240

Gain on sale of machine = $ 95,000 - $ 89,240 = $ 5,760

Tax on gain = $ 5,760 x 0.33 = $ 1,900.80

After-tax salvage value of machine = $ 95,000 - $ 1,900.80 = $ 93,099.20...........(2)

Net cash flow in the 5th year = ( 1 ) + ( 2 ) = $ 75,437.60 + $ 93,099.20 = $ 168,536.80