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.
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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