Question

1, i)

MACRS                         Year 1       Year 2       Year 3        Year 4        Year 5       Year 6
Depreciation Rate      20%            32%        19.2%        11.52%        11.52%       5.76%
A company invests $26477 in new machinery, which was depreciated using the five-year MACRS schedule shown above. If the company sold the machinery immediately after the end of year 3 for $13427, what is the after-tax salvage value from the sale, given a tax rate of 26%? Enter your answer in dollars and round to the nearest dollar.

ii) You are considering adding a new division into your existing firm. This will entail an increase in inventory of $8882, an increase in accounts payables of $2292, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the new division is _______________. Enter your answer in dollars and round to the nearest dollar. (Also, show how to put it in TI-83 plus Calculator)

iii) Company XYZ, an all-equity firm, reported incremental revenues (net income) of $375 million for the most recent year. The firm had depreciation expenses of $146 million and capital expenditures of $171 million. The company also had an increase in net working capital of $20 million. What is the free cash flow? Enter your answer in dollars and round to the nearest dollar. (Also, show how to put it in TI-83 Calculator)

Answer 1

1.Cost of new machinery = $26,477

Written down value of machine at the end of year 3 = 26,477*(100-20-32-19.2)%

= $7,625.376

Sale Value = $13,427

Profit on sale = 5,801.624

Tax @ 26% = $1,508.42

After Tax Salvage Value = $13,427 - $1,508.42 = $11,918.58

2.Net working capital = Current assets – current liabilities

= 8,882 -2,292

= $6,590

Hence, net working capital will increase by $6,590

Note: Property, Plant and Equipment are not a part of current assets

3.Incremental Revenues = $375 million

Add: Depreciation Expense (non-cash) = $146 million

Less: Capital Expenditure = $171 million

Less: Increase in Net working capital = $20 million

Free cash flow = $330 million