Question

# Big-Pear Corp. is considering replacing its existing equipment that is used to produce smart cell phones....

Big-Pear Corp. is considering replacing its existing equipment that is used to produce smart cell phones. This existing equipment was purchase 3 years ago at a base price of \$60,000. Installation costs at the time for the machine were \$7,000. The existing equipment is considered a 5-year class for MACRS. The existing equipment can be sold today for \$60,000 and for \$20,000 in 3 years. The new equipment has a purchase price of \$150,000 and is also considered a 5-year class for MACRS. Installation costs for the new equipment are \$8,000. The estimated salvage value of the new equipment is \$80,000. This new equipment is more efficient than the existing one and thus savings before taxes using the new equipment are \$11,000 a year. Due to these savings, inventories will see a one time reduction of \$4,000 at the time of replacement. The company's marginal tax rate is 20% and the cost of capital is 12%. For this project, what is the incremental cash flow in year 2?

 MACRS Fixed Annual Expense Percentages by Recovery Class Year 3-Year 5-Year 7-Year 10-Year 15-Year 1 33.33% 20.00% 14.29% 10.00% 5.00% 2 44.45% 32.00% 24.49% 18.00% 9.50% 3 14.81% 19.20% 17.49% 14.40% 8.55% 4 7.41% 11.52% 12.49% 11.52% 7.70% 5 11.52% 8.93% 9.22% 6.93% 6 5.76% 8.93% 7.37% 6.23% 7 8.93% 6.55% 5.90% 8 4.45% 6.55% 5.90% 9 6.56% 5.91% 10 6.55% 5.90% 11 3.28% 5.91% 12 5.90% 13 5.91% 14 5.90% 15 5.91% 16 2.95%

Depreciation on new Equipment in Year 2 = Cost * 32% = \$158000 * 32% = 50560.00

Depreciation on old Equipment in Year 2 = Cost * 11.52% = \$67000 * 32% = 7718.40