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CHPT 10
CHPT 10
lates
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Problem 10-6
Calculate Depreciation Allowances and Book Values under MACRS.
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A piece of newly purchase industrial equipment costs $736,000 and is classified as seven-year property
under MACRS. Calculate the annual depreciation allowances and end-of-the-year book values for this equipment.
Solution
Instructions
Using the MACRS depreciation schedule shown below, enter data and formulas to calculate annual
depreciation allowances and end-of-the-year book values for the equipment.
Property Class
Year 3-Year 5-Year 7-Year
1 33.30% 20.00% 14.29%
2 44.44% 32.00% 24.49%
3 14.82% 19.20% 17.49%
4 7.41% 11.52% 12.49%
5 11.52% 8.93%
6 5.76% 8.93%
7 8.93%
8 4.45%
What-if Analysis
Instructions
Click one of the scenario buttons to see the "what if" question. With each scenario, refer back to the
original data of the problem. Solve the scenario question by utilizing the MACRS depreciation template
given below. Be sure to print your results before moving on to the next scenario.
What-if: (Scenario 1)
The equipment is classified as 3 year property.
Scenario 2
Beginning Annual Accumulated Ending
Book Value Depreciation Depreciation Book Value
1 FORMULA $0
2 0 FORMULA FORMULA #VALUE!
3 #VALUE! FORMULA FORMULA #VALUE!
4 #VALUE! FORMULA FORMULA #VALUE!
5 #VALUE! FORMULA FORMULA #VALUE!
6 #VALUE! FORMULA FORMULA #VALUE!
Total $0
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Consider an asset that costs $248,000 and is depreciated straight-line to zero over its eight-year tax life.
The asset is to be used in a five-year project; at the end of the project, the asset can be sold for $50,000. If
the relevant tax rate is 35 percent, what is the after tax cash flow from the sale of this asset?
Solution
Instructions
Enter the data and the depreciation SLN Excel function to calculate the after tax cash flow from
the sale of the asset.
Useful life (in years)
Tax Rate
Asset disposal price
Selling price $0
Book Value #VALUE!
Gain or (loss) #VALUE!
Tax savings #VALUE!
Add selling price 0
Salvage Value #VALUE!
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Clinton Carbide, Inc. is considering a new three-year expansion project that requires an initial fixed asset
investment of $1.8 million. The fixed asset will be depreciated straight-line to zero over its three-year tax
life, after which time it will be worthless. The project is estimated to generate $1,850,000 in annual sales,
with costs of $650,000. If the tax rate is 35%, what is the OCF for this project?
Solution
Instructions
Enter data and formulas to calculate operating cash flow.
Annual Sales
Annual Costs
Annual Depreciation FORMULA
Taxable Income #VALUE!
Taxes rate = 35% #VALUE!
Net Income #VALUE!
Plus Depreciation
Operating Cash Flow FORMULA
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Bendog’s Franks is looking at a new sausage system with an installed cost of $305,000. This cost will be
depreciated straight-line to zero over the project’s five-year life, at the end of which the sausage system
can be scrapped for $60,000. The sausage system will save the firm $90,000 per year in pretax operating
costs, and the system requires an initial investment in net working capital of $27,000. If the tax rate is 34
percent and the discount rate is 10 percent, what is the NPV of this project?
Solution
Instructions
Enter data and use the NPV formula to calculate NPV.
Discount Rate
Installed cost
Useful life (years)
Tax Rate
Years 0 1 2 3 4 5
Savings $90,000 $90,000 $90,000 $90,000 $90,000
Depreciation #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
Taxable Income #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
Taxes #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
Net Income #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
Add: Depreciation #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
Operating Cash Flow #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
Initial Investment $0
NWC (27,000)
Salvage Value FORMULA
Project Cash Flow ($27,000) #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
NPV FORMULA
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You are evaluating two different silicon wafer milling machines. The Techron I costs $180,000, has a three-
year life, and has pretax operating costs of $30,000 per year. The Techron II costs $280,000, has a five-
year life, and has pretax operating costs of $17,000 per year. For both milling machines, use straight-line
depreciation to zero over the project’s life and assume a salvage value of $25,000. If your tax rate is 35
percent and your discount rate is 18 percent, compute the EAC for both machines. Which do you prefer?
Why?
Solution
Instructions
Enter cash outflows as negative numbers. Use the NPV function to calculate Net Present Values.
Techron I
Years 0 1 2 3
Machine cost
Operating costs ($30,000) ($30,000) ($30,000)
Depreciation 0 0 0
Taxable income (Loss) (30,000) (30,000) (30,000)
Tax savings FORMULA FORMULA FORMULA
Operating income #VALUE! #VALUE! #VALUE!
Cash flow 0 #VALUE! #VALUE! #VALUE!
Techron II
Years 0 1 2 3 4 5
Machine cost
Operating costs ($17,000) ($17,000) ($17,000) ($17,000) ($17,000)
Depreciation 0 0 0 0 0
Taxable income (Loss) (17,000) (17,000) (17,000) (17,000) (17,000)
Tax savings FORMULA FORMULA FORMULA FORMULA FORMULA
Operating income #VALUE! #VALUE! #VALUE! #VALUE! #VALUE!
Cash flow 0 #VALUE! #VALUE! #VALUE! #VALUE! #VALUE!
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Pags Industrial Systems Company (PISC) is trying to decide between two different conveyor belt systems.
System A costs $450,000, has a three-year life, and requires $140,000 in pretax annual operating costs.
System B costs $500,000, has a five-year life, and requires $75,000 in pretax annual operating costs. Both
systems are to be depreciated straight-line to zero over their lives and will have zero salvage value.
Whichever project is chosen, it will not be replaced when it wears out. If the tax rate is 34 percent and the
Solution
Instructions
Use the Excel NPV function to calculate the net present value of two projects. Enter cash outflows as
negative numbers.
System A
Years 0 1 2 3
Machine cost
Operating costs ($140,000) ($140,000) ($140,000)
Depreciation FORMULA FORMULA FORMULA
Salvage value 0
Taxable income (Loss) #VALUE! #VALUE! #VALUE!
Tax savings #VALUE! #VALUE! #VALUE!
Operating income #VALUE! #VALUE! #VALUE!
Cash flow $0 #VALUE! #VALUE! #VALUE!
Net present value FORMULA
System B
Years 0 1 2 3 4 5
Machine cost
Operating costs ($75,000) ($75,000) ($75,000) ($75,000) ($75,000)
Depreciation FORMULA
Salvage value 0
Taxable income (Loss) #VALUE! (75,000) (75,000) (75,000) (75,000)
Tax savings #VALUE! 25,500 25,500 25,500 25,500
Operating income #VALUE! (49,500) (49,500) (49,500) (49,500)
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Mariah-in-You (PIY), Inc. projects unit sales for a new 7-octave voice emulation implant as follows:
3 110,000
4 114,000
5 75,000
Production of implants will require $600,000 in net working capital to start and additional net working capital
investments each year equal to 40 percent of the projected sales increase for the following year.
(Because sales are expected to fall in Year 5, there is no NWC cash flow occurring for Year 4.) Total fixed
costs are $200,000 per year, variable production costs are $200 per unit, and the units are priced at $325
each. The equipment needed to begin production has an installed cost of $13,250,000. Because the implants
are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as
seven-year MACRS property. In five years, this equipment can be sold for about 30 percent of its acquisition
cost. PIY is in the 35 percent marginal tax bracket and has a required return on all its projects of 30 percent.
Based on these preliminary project estimates, what is the NPV of the project? What is the IRR?
Solution
Instructions
Enter data from the problem and NPV and IRR functions to solve this problem.
Required return
Tax rate
Years 0 1 2 3 4 5