Rockyford Company must replace some machinery that has zero book value and a current market value of $4,000. One possibility is to invest in new machinery costing $30,000. This new machinery would produce estimated annual pretax cash operating savings of $12,000. Assume the new machine will have a useful life of 4 years and depreciation of $7,500 each year for book and tax purposes. It will have no salvage value at the end of 4 years. The investment in this new machinery would require an additional $2,500 investment of net working capital. (Assume that when the old machine was purchased, the incremental net working capital required at the time was $0.) If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment are expected to occur over a four-year period. Rockyford is subject to a 40% income tax rate for all ordinary income and capital gains and has a 7% weighted-average after-tax cost of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix C- Table 1 or Table 2.) Required: 1. Determine the after-tax cash flow arising from disposing of the old machinery. 2. Determine the present value of the after-tax cash flows for the next 4-years attributable to the cash operating savings. 3. Determine the present value of the tax shield effect of depreciation for year 1. 4. Which one of the following is the proper treatment for the additional $2,500 of net working capital required in the current year?
Rockyford Company must replace some machinery that has zero book value and a current market value of $4,000. One possibility is to invest in new machinery costing $30,000. This new machinery would produce estimated annual pretax cash operating savings of $12,000. Assume the new machine will have a useful life of 4 years and depreciation of $7,500 each year for book and tax purposes. It will have no salvage value at the end of 4 years. The investment in this new machinery would require an additional $2,500 investment of net working capital. (Assume that when the old machine was purchased, the incremental net working capital required at the time was $0.) If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment are expected to occur over a four-year period. Rockyford is subject to a 40% income tax rate for all ordinary income and capital gains and has a 7% weighted-average after-tax cost of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix C- Table 1 or Table 2.) Required: 1. Determine the after-tax cash flow arising from disposing of the old machinery. 2. Determine the present value of the after-tax cash flows for the next 4-years attributable to the cash operating savings. 3. Determine the present value of the tax shield effect of depreciation for year 1. 4. Which one of the following is the proper treatment for the additional $2,500 of net working capital required in the current year?
Fundamentals Of Financial Management, Concise Edition (mindtap Course List)
10th Edition
ISBN:9781337902571
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Eugene F. Brigham, Joel F. Houston
Chapter12: Cash Flow Estimation And Risk Analysis
Section: Chapter Questions
Problem 10P: Dauten is offered a replacement machine which has a cost of 8,000, an estimated useful life of 6...
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Transcribed Image Text:Rockyford Company must replace some machinery that has zero book value and a current market value of $4,000. One possibility is
to invest in new machinery costing $30,000. This new machinery would produce estimated annual pretax cash operating savings of
$12,000. Assume the new machine will have a useful life of 4 years and depreciation of $7,500 each year for book and tax purposes. It
will have no salvage value at the end of 4 years. The investment in this new machinery would require an additional $2,500 investment
of net working capital. (Assume that when the old machine was purchased, the incremental net working capital required at the time
was $0.)
If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on
December 31 of this year. The cash flows from the investment are expected to occur over a four-year period.
Rockyford is subject to a 40% income tax rate for all ordinary income and capital gains and has a 7% weighted-average after-tax cost of
capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix C-
Table 1 or Table 2.)
Required:
1. Determine the after-tax cash flow arising from disposing of the old machinery.
2. Determine the present value of the after-tax cash flows for the next 4-years attributable to the cash operating savings.
3. Determine the present value of the tax shield effect of depreciation for year 1.
4. Which one of the following is the proper treatment for the additional $2,500 of net working capital required in the current year?
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