Reading 31- LOS a～ Q1－4 class, reduce, purchase, machine

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1.Jayco, Inc. is considering the purchase of a new machine for $60,000 that will reduce manufacturing costs by $5,000 annually.

§ Jayco will use the MACRS accelerated method (5 year asset) to depreciate the machine, and expects to sell the machine at the end of its 6-year operating life for $10,000. (The percentages for the 5-year MACRS class are, beginning with year 1 and ending with year 6, 20%, 32%, 19%, 12%, 11%, and 6%.)

§ The firm expects to be able to reduce net working capital by $15,000 when the machine is installed, but required working capital will return to the original level when the machine is sold after 6 years.

§ Jayco's marginal tax rate is 40 percent, and it uses a 12 percent cost of capital to evaluate projects of this nature. Use this data for the next 4 questions.

What is the first year's modified accelerated cost recovery system (MACRS) depreciation?

A)   $12,000.

B)   $10,000.

C)   $15,000.

D)   $19,000.

2.What is the initial cash outlay?

A)   $45,000.

B)   $15,000.

C)   $60,000.

D)   $75,000.

3.What is the first year's operating cash flow?

A)   $3,000.

B)   $7,800.

C)   $4,800.

D)   $6,000.

4.What is the terminal year's cash flow (not counting the last year's operating cash flow)?

A)   ($9000).

B)   ($4,000).

C)   $9,000.

D)   $21,000.

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1.Jayco, Inc. is considering the purchase of a new machine for $60,000 that will reduce manufacturing costs by $5,000 annually.

§ Jayco will use the MACRS accelerated method (5 year asset) to depreciate the machine, and expects to sell the machine at the end of its 6-year operating life for $10,000. (The percentages for the 5-year MACRS class are, beginning with year 1 and ending with year 6, 20%, 32%, 19%, 12%, 11%, and 6%.)

§ The firm expects to be able to reduce net working capital by $15,000 when the machine is installed, but required working capital will return to the original level when the machine is sold after 6 years.

§ Jayco's marginal tax rate is 40 percent, and it uses a 12 percent cost of capital to evaluate projects of this nature. Use this data for the next 4 questions.

What is the first year's modified accelerated cost recovery system (MACRS) depreciation?

A)   $12,000.

B)   $10,000.

C)   $15,000.

D)   $19,000.

The correct answer was A)

The first year MACRS depreciation equals 60,000* 20%, or 60,000 * 0.2 = 12,000.

2.What is the initial cash outlay?

A)   $45,000.

B)   $15,000.

C)   $60,000.

D)   $75,000.

The correct answer was A)

Initial cash outlay = up-front costs (including cost) and changes in working capital. Here, the price of the machine is 60,000 and the working capital initally decreases 15,000 (which is a source of funds). Thus, the initial cash outlay = 60,000 cost - 15,000 working capital = 45,000.

3.What is the first year's operating cash flow?

A)   $3,000.

B)   $7,800.

C)   $4,800.

D)   $6,000.

The correct answer was B)

The first year's cash flow equals the after-tax impact of the 5,000 operating savings and the depreciation tax shield, or (5,000)(.6) + (60,000)(.2)(.4) = 3,000 + 4,800 = 7,800.

4.What is the terminal year's cash flow (not counting the last year's operating cash flow)?

A)   ($9000).

B)   ($4,000).

C)   $9,000.

D)   $21,000.

The correct answer was A)

The terminal cash flow = [Sales (salvage) price - book value] * (1 - tax rate) +/- change in working capital. Here, = (10,000 - 0)*(1 - 0.40) - 15,000 (increased working capital is a use of funds) = 6,000 - 15,000 = -9,000.

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