P11–27

Integrative—Determining relevant cash flows

Atlantic Drydock is considering replacing an existing hoist with one of two newer, more efficient
pieces of equip- ment. The existing hoist is 3 years old, cost $32,000, and is being depreciated under
MACRS using a 5-year recovery period. Although the existing hoist has only 3 years (years 4, 5, and 6) of
depreciation remaining under MACRS, it has a remaining usable life of 5 years. Hoist A, one of the two
possible replacement hoists, costs $40,000 to purchase and $8,000 to install. It has a 5-year usable life
and will be depreciated under MACRS using a 5-year recovery period. Hoist B costs $54,000 to purchase
and $6,000 to install. It also has a 5-year usable life and will be depreci- ated under MACRS using a 5-
year recovery period.
Increased investments in net working capital will accompany the decision to acquire hoist A or
hoist B. Purchase of hoist A would result in a $4,000 increase in net working capital; hoist B would
result in a $6,000 increase in net working capital. The projected earnings before depreciation, interest,
and taxes with each alternative hoist and the existing hoist are given in the following table.

Earnings before
depreciation, interest, and taxes
Year With hoist A With hoist B With existing hoist
1 $ 21,000 $ 22,000 $ 14,000
2 $ 21,000 $ 24,000 $ 14,000
3 $ 21,000 $ 26,000 $ 14,000
4 $ 21,000 $ 26,000 $ 14,000
5 $ 21,000 $ 26,000 $ 14,000

The existing hoist can currently be sold for $18,000 and will not incur any removal or cleanup costs.
At the end of 5 years, the existing hoist can be sold to net $1,000 before taxes. Hoists A and B can be
sold to net $12,000 and $20,000 before taxes, respectively, at the end of the 5-year period. The firm is
subject to a 40% tax rate. (Table 4.2 on page 117 contains the applicable MACRS deprecia- tion
percentages.)
a. Calculate the initial investment associated with each alternative.
b. Calculate the incremental operating cash inflows associated with each alternative. (Note: Be sure to
consider the depreciation in year 6.)
c. Calculate the terminal cash flow at the end of year 5 associated with each alternative.
d. Depict on a time line the relevant cash flows associated with each alternative.

Hoist A
Year Cost Rate Depreciation NBV
1 $ 48,000 20% $ 9,600 $ 38,400
2 $ 48,000 32% $ 15,360 $ 23,040
3 $ 48,000 19% $ 9,120 $ 13,920
4 $ 48,000 12% $ 5,760 $ 8,160
5 $ 48,000 12% $ 5,760 $ 2,400
6 $ 48,000 5% $ 2,400 $ -
Hoist B
Year Cost Rate Depreciation NBV
1 $ 60,000 20% $ 12,000 $ 48,000
2 $ 60,000 32% $ 19,200 $ 28,800
3 $ 60,000 19% $ 11,400 $ 17,400
4 $ 60,000 12% $ 7,200 $ 10,200
5 $ 60,000 12% $ 7,200 $ 3,000
6 $ 60,000 5% $ 3,000 $ -

Existing Hoist
Year Cost Rate Depreciation NBV
1 $ 32,000 20% $ 6,400 $ 25,600 Already
2 $ 32,000 32% $ 10,240 $ 15,360 Used for
3 $ 32,000 19% $ 6,080 $ 9,280 3 Years
1 $ 32,000 12% $ 3,840 $ 5,440 << Restart (Rate continue)
2 $ 32,000 12% $ 3,840 $ 1,600
3 $ 32,000 5% $ 1,600 $ -
4 $ - $ -
5 $ - $ -
6 $ - $ -
Answer:

A. INITIAL INVESTMENT Hoist A Hoist B

Installed cost of proposed machine
Cost of proposed machine $ 40,000 $ 54,000
+ Installation Costs $ 8,000 $ 6,000
Total installed cost—proposed (depreciable value) $ 48,000 $ 60,000
- After-tax proceeds from sale of present machine
Proceeds from sale of present machine $ 18,000 $ 18,000
- Tax on sale of present machine $ 3,488 $ 3,488
Total after-tax proceeds—present $ 14,512 $ 14,512
+ Change in net working capital $ 4,000 $ 6,000
Initial investment $ 37,488 $ 51,488

B. INCREMENTAL OPERATING CASH INFLOWS

Calculation of Operating Cash Inflows Year 1 Year 2
With Hoist A
Earnings before depreciation, interest, and taxes $ 21,000 $ 21,000
- Depreciation $ 9,600 $ 15,360
Earnings before interest, and taxes $ 11,400 $ 5,640
- Taxes (rate, T = 40%) $ 4,560 $ 2,256
Net operating profit after taxes $ 6,840 $ 3,384
+ Depreciation $ 9,600 $ 15,360
Operating cash inflows $ 16,440 $ 18,744
With Hoist B
Earnings before depreciation, interest, and taxes $ 22,000 $ 24,000
- Depreciation $ 12,000 $ 19,200
Earnings before interest, and taxes $ 10,000 $ 4,800
- Taxes (rate, T = 40%) $ 4,000 $ 1,920
Net operating profit after taxes $ 6,000 $ 2,880
+ Depreciation $ 12,000 $ 19,200
Operating cash inflows $ 18,000 $ 22,080
With Existing Hoist
Earnings before depreciation, interest, and taxes $ 14,000 $ 14,000
- Depreciation $ 3,840 $ 3,840
Earnings before interest, and taxes $ 10,160 $ 10,160
- Taxes (rate, T = 40%) $ 4,064 $ 4,064
Net operating profit after taxes $ 6,096 $ 6,096
+ Depreciation $ 3,840 $ 3,840
Operating cash inflows $ 9,936 $ 9,936

Incremental (Relevant) Operating Cash Inflows

 Operating cash inflows
Year Hoist A Existing Hoist
Hoist B [2]
[1] [3]

1 $ 16,440 $ 18,000 $ 9,936

2 $ 18,744 $ 22,080 $ 9,936
3 $ 16,248 $ 20,160 $ 9,040
4 $ 14,904 $ 18,480 $ 8,400
5 $ 14,904 $ 18,480 $ 8,400
6 $ 960 $ 1,200 $ -

estart (Rate continue)

 C. TERMINAL CASH FLOW
After-tax proceeds from sale of proposed machine
Proceeds from sale of proposed machine
- Tax on sale of proposed machine
Total after-tax proceeds—proposed
After-tax proceeds from sale of present machine
Proceeds from sale of present machine
- Tax on sale of present machine
Total after-tax proceeds—present
+ Change in net working capital
Terminal cash flow

Year 5 relevant cash flow

Year 3 Year 4 Year 5 Year 6 Operating cash flow
Terminal cash flow
$ 21,000 $ 21,000 $ 21,000 Total inflow
$ 9,120 $ 5,760 $ 5,760 $ 2,400
$ 11,880 $ 15,240 $ 15,240 $ (2,400) D. TIME LINE OF THE RELEVANT CASH FLOWS
$ 4,752 $ 6,096 $ 6,096 $ (960) Hoist A
$ 7,128 $ 9,144 $ 9,144 $ (1,440)
$ 9,120 $ 5,760 $ 5,760 $ 2,400
$ 16,248 $ 14,904 $ 14,904 $ 960 $ 6,504 $ 8,808

$ 26,000 $ 26,000 $ 26,000 0

$ 11,400 $ 7,200 $ 7,200 $ 3,000 1 2
$ 14,600 $ 18,800 $ 18,800 $ (3,000) End of year
$ 5,840 $ 7,520 $ 7,520 $ (1,200) $ 37,488
$ 8,760 $ 11,280 $ 11,280 $ (1,800) (initial investment)
$ 11,400 $ 7,200 $ 7,200 $ 3,000
$ 20,160 $ 18,480 $ 18,480 $ 1,200 Hoist B

$ 14,000 $ 14,000 $ 14,000

$ 1,600 $ 8,064 $ 12,144
$ 12,400 $ 14,000 $ 14,000 $ -
$ 4,960 $ 5,600 $ 5,600 $ - 0
$ 7,440 $ 8,400 $ 8,400 $ - 1 2
$ 1,600 $ - $ - $ - End of year
$ 9,040 $ 8,400 $ 8,400 $ - $ 51,488
(initial investment)
ash inflows
Incremental cash flow
Hoist A Hoist B
[1] - [3] [2] - [3]
$ 6,504 $ 8,064
$ 8,808 $ 12,144
$ 7,208 $ 11,120
$ 6,504 $ 10,080
$ 6,504 $ 10,080
$ 960 $ 1,200
 Hoist A Hoist B
sale of proposed machine
f proposed machine $ 12,000 $ 20,000
ed machine $ 3,840 $ 6,800
oceeds—proposed $ 8,160 $ 13,200
sale of present machine
f present machine $ 1,000 $ 1,000
$ 400 $ 400
oceeds—present $ 600 $ 600
$ 4,000 $ 6,000
$ 11,560 $ 18,600

$ 6,504 $ 10,080
$ 11,560 $ 18,600
$ 18,064 $ 28,680

ANT CASH FLOWS

$ 6,504 Operating cash flow

$ 11,560 Terminal cash flow
$ 7,208 $ 6,504 $ 18,064 Total Cash Flow

3 4 5
End of year

$ 10,080 Operating cash flow

$ 18,600 Terminal cash flow
$ 11,120 $ 10,080 $ 28,680 Total Cash Flow

3 4 5
End of year
Spreadsheet Exercise

Damon Corporation, a sports equipment manufacturer, has a machine currently in use that was
originally purchased 3 years ago for $120,000. The firm depreciates the machine under MACRS using a
5-year recovery period. Once removal and cleanup costs are taken into consideration, the expected net
selling price for the present machine will be $70,000.
Damon can buy a new machine for a net price of $160,000 (including installation costs of $15,000).
The proposed machine will be depreciated under MACRS using a 5-year recovery period. If the firm
acquires the new machine, its working capital needs will change—accounts receivable will increase
$15,000, inventory will increase $19,000, and accounts payable will increase $16,000.
Earnings before depreciation, interest, and taxes (EBDIT) for the present machine are expected to
be $95,000 for each of the successive 5 years. For the proposed machine, the expected EBDIT for each
of the next 5 years are $105,000, $110,000, $120,000, $120,000, and $120,000, respectively. The
corporate tax rate (T) for the firm is 40%. (Table 4.2 on page 117 contains the applicable MACRS
depreciation percentages.)
Damon expects to be able to liquidate the proposed machine at the end of its 5-year usable life for
$24,000 (after paying removal and cleanup costs). The present machine is expected to net $8,000 upon
liquidation at the end of the same period. Damon expects to recover its net working capital investment
upon termination of the project. The firm is subject to a tax rate of 40%.
Create a spreadsheet similar to Tables 11.1, 11.5, 11.7, and 11.9 to answer the following:
a. Create a spreadsheet to calculate the initial investment.
b. Create a spreadsheet to prepare a depreciation schedule for both the proposed
and the present machine. Both machines are depreciated under MACRS using a 5-year recovery period.
Remember, the present machine has only 3 years of depreciation remaining.
c. Create a spreadsheet to calculate the operating cash inflows for Damon Corporation for both the
proposed and the present machine.
d. Create a spreadsheet to calculate the terminal cash flow associated with the project.

New Machine
Year Cost Rate Depreciation NBV
1 $ 160,000 20% $ 32,000 $ 128,000
2 $ 160,000 32% $ 51,200 $ 76,800
3 $ 160,000 19% $ 30,400 $ 46,400
4 $ 160,000 12% $ 19,200 $ 27,200
5 $ 160,000 12% $ 19,200 $ 8,000
6 $ 160,000 5% $ 8,000 $ -

Present Machine
Year Cost Rate Depreciation NBV
1 $ 120,000 20% $ 24,000 $ 96,000 Already
2 $ 120,000 32% $ 38,400 $ 57,600 Used for
3 $ 120,000 19% $ 22,800 $ 34,800 3 Years
1 $ 120,000 12% $ 14,400 $ 20,400 << Restart (Rate continue)
2 $ 120,000 12% $ 14,400 $ 6,000
3 $ 120,000 5% $ 6,000 $ -
4 $ - $ -
5 $ - $ -
6 $ - $ -
Answer:

A. INITIAL INVESTMENT
Installed cost of proposed machine
Cost of proposed machine $ 145,000
+ Installation Costs $ 15,000
Total installed cost—proposed (depreciable value) $ 160,000
- After-tax proceeds from sale of present machine
Proceeds from sale of present machine $ 70,000
- Tax on sale of present machine $ 14,080
Total after-tax proceeds—present $ 55,920
+ Change in net working capital $ 18,000
Initial investment $ 122,080

B. INCREMENTAL OPERATING CASH INFLOWS

Calculation of Operating Cash Inflows Year 1 Year 2
With New Machine
Earnings before depreciation, interest, and taxes $ 105,000 $ 110,000
- Depreciation $ 32,000 $ 51,200
Earnings before interest, and taxes $ 73,000 $ 58,800
- Taxes (rate, T = 40%) $ 29,200 $ 23,520
Net operating profit after taxes $ 43,800 $ 35,280
+ Depreciation $ 32,000 $ 51,200
Operating cash inflows $ 75,800 $ 86,480
With Present Machine
Earnings before depreciation, interest, and taxes $ 95,000 $ 95,000
- Depreciation $ 14,400 $ 14,400
Earnings before interest, and taxes $ 80,600 $ 80,600
- Taxes (rate, T = 40%) $ 32,240 $ 32,240
Net operating profit after taxes $ 48,360 $ 48,360
+ Depreciation $ 14,400 $ 14,400
Operating cash inflows $ 62,760 $ 62,760

Incremental (Relevant) Operating Cash Inflows

Operating cash inflows
Year New Machine Present Machine Incremental (relevant)
[1] [2] [1] - [2]
1 $ 75,800 $ 62,760 $ 13,040
2 $ 86,480 $ 62,760 $ 23,720
3 $ 84,160 $ 59,400 $ 24,760
4 $ 79,680 $ 57,000 $ 22,680
5 $ 79,680 $ 57,000 $ 22,680
 6 $ 3,200 $ - $ 3,200
estart (Rate continue)
 C. TERMINAL CASH FLOW
After-tax proceeds from sale of proposed machine
Proceeds from sale of proposed machine
- Tax on sale of proposed machine
Total after-tax proceeds—proposed
After-tax proceeds from sale of present machine
Proceeds from sale of present machine
- Tax on sale of present machine
Total after-tax proceeds—present
+ Change in net working capital
Terminal cash flow

Year 5 relevant cash flow

Year 3 Year 4 Year 5 Year 6 Operating cash flow
Terminal cash flow
$ 120,000 $ 120,000 $ 120,000 Total inflow
$ 30,400 $ 19,200 $ 19,200 $ 8,000
$ 89,600 $ 100,800 $ 100,800 $ (8,000) D. TIME LINE OF THE RELEVANT CASH FLOWS
$ 35,840 $ 40,320 $ 40,320 $ (3,200) New Machine
$ 53,760 $ 60,480 $ 60,480 $ (4,800)
$ 30,400 $ 19,200 $ 19,200 $ 8,000
$ 84,160 $ 79,680 $ 79,680 $ 3,200 $ 13,040 $ 23,720

$ 95,000 $ 95,000 $ 95,000 0

$ 6,000 1 2
$ 89,000 $ 95,000 $ 95,000 $ - End of year
$ 35,600 $ 38,000 $ 38,000 $ - $ 122,080
$ 53,400 $ 57,000 $ 57,000 $ - (initial investment)
$ 6,000 $ - $ - $ -
$ 59,400 $ 57,000 $ 57,000 $ -
 New Machine
sale of proposed machine
f proposed machine $ 24,000
ed machine $ 6,400
oceeds—proposed $ 17,600
sale of present machine
f present machine $ 8,000
$ 3,200
oceeds—present $ 4,800
$ 18,000
$ 30,800

$ 22,680
$ 30,800
$ 53,480

ANT CASH FLOWS

$ 22,680 Operating cash flow

$ 30,800 Terminal cash flow
$ 24,760 $ 22,680 $ 53,480 Total Cash Flow

3 4 5
End of year
Spreadsheet Exercise

Damon Corporation, a sports equipment manufacturer, has a machine currently in use that was
originally purchased 3 years ago for $120,000. The firm depreciates the machine under MACRS using a
5-year recovery period. Once removal and cleanup costs are taken into consideration, the expected net
selling price for the present machine will be $70,000.
Damon can buy a new machine for a net price of $160,000 (including installation costs of $15,000).
The proposed machine will be depreciated under MACRS using a 5-year recovery period. If the firm
acquires the new machine, its working capital needs will change—accounts receivable will increase
$15,000, inventory will increase $19,000, and accounts payable will increase $16,000.
Earnings before depreciation, interest, and taxes (EBDIT) for the present machine are expected to
be $95,000 for each of the successive 5 years. For the proposed machine, the expected EBDIT for each
of the next 5 years are $105,000, $110,000, $120,000, $120,000, and $120,000, respectively. The
corporate tax rate (T) for the firm is 40%. (Table 4.2 on page 117 contains the applicable MACRS
depreciation percentages.)
Damon expects to be able to liquidate the proposed machine at the end of its 5-year usable life for
$24,000 (after paying removal and cleanup costs). The present machine is expected to net $8,000 upon
liquidation at the end of the same period. Damon expects to recover its net working capital investment
upon termination of the project. The firm is subject to a tax rate of 40%.
Create a spreadsheet similar to Tables 11.1, 11.5, 11.7, and 11.9 to answer the following:
a. Create a spreadsheet to calculate the initial investment.
b. Create a spreadsheet to prepare a depreciation schedule for both the proposed
and the present machine. Both machines are depreciated under MACRS using a 5-year recovery period.
Remember, the present machine has only 3 years of depreciation remaining.
c. Create a spreadsheet to calculate the operating cash inflows for Damon Corporation for both the
proposed and the present machine.
d. Create a spreadsheet to calculate the terminal cash flow associated with the project.

Tambahan Soal:
Cost of Capital 10%
Inflation Rate 8%
Depreciation Method = Reducing Balance

New Machine
Year Cost Rate Depreciation NBV
1 $ 160,000 40% $ 60,800 $ 99,200
2 $ 160,000 40% $ 36,480 $ 62,720
3 $ 160,000 40% $ 21,888 $ 40,832
4 $ 160,000 40% $ 13,133 $ 27,699
5 $ 160,000 40% $ 7,880 $ 19,820
Present Machine
Year Cost Rate Depreciation NBV
1 $ 120,000 20% $ 24,000 $ 96,000 Already
2 $ 120,000 32% $ 38,400 $ 57,600 Used for
3 $ 120,000 19% $ 22,800 $ 34,800 3 Years
1 $ 120,000 12% $ 14,400 $ 20,400 << Restart (Rate continue)
2 $ 120,000 12% $ 14,400 $ 6,000
3 $ 120,000 5% $ 6,000 $ -
4 $ - $ -
5 $ - $ -
6 $ - $ -
Answer:

A. INITIAL INVESTMENT
Installed cost of proposed machine
Cost of proposed machine $ 145,000
+ Installation Costs $ 15,000
Total installed cost—proposed (depreciable value) $ 160,000
- After-tax proceeds from sale of present machine
Proceeds from sale of present machine $ 70,000
- Tax on sale of present machine $ 14,080
Total after-tax proceeds—present $ 55,920
+ Change in net working capital $ 18,000
Initial investment $ 122,080

B. INCREMENTAL OPERATING CASH INFLOWS

Calculation of Operating Cash Inflows Year 1 Year 2
With New Machine
Earnings before depreciation, interest, and taxes $ 105,000 $ 110,000
- Depreciation $ 60,800 $ 36,480
Earnings before interest, and taxes $ 44,200 $ 73,520
- Taxes (rate, T = 40%) $ 17,680 $ 29,408
Net operating profit after taxes $ 26,520 $ 44,112
+ Depreciation $ 60,800 $ 36,480
Operating cash inflows $ 87,320 $ 80,592
With Present Machine
Earnings before depreciation, interest, and taxes $ 95,000 $ 95,000
- Depreciation $ 14,400 $ 14,400
Earnings before interest, and taxes $ 80,600 $ 80,600
- Taxes (rate, T = 40%) $ 32,240 $ 32,240
Net operating profit after taxes $ 48,360 $ 48,360
+ Depreciation $ 14,400 $ 14,400
Operating cash inflows $ 62,760 $ 62,760

Incremental (Relevant) Operating Cash Inflows

Operating cash inflows
Year New Machine Present Machine Incremental (relevant)
[1] [2] [1] - [2]
1 $ 87,320 $ 62,760 $ 24,560
2 $ 80,592 $ 62,760 $ 17,832
3 $ 80,755 $ 59,400 $ 21,355
4 $ 77,253 $ 57,000 $ 20,253
5 $ 75,152 $ 57,000 $ 18,152
 6 $ - $ - $ -

estart (Rate continue)

 C. TERMINAL CASH FLOW
After-tax proceeds from sale of proposed machine
Proceeds from sale of proposed machine
- Tax on sale of proposed machine
Total after-tax proceeds—proposed
After-tax proceeds from sale of present machine
Proceeds from sale of present machine
- Tax on sale of present machine
Total after-tax proceeds—present
+ Change in net working capital
Terminal cash flow

Year 5 relevant cash flow

Year 3 Year 4 Year 5 Year 6 Operating cash flow
Terminal cash flow
$ 120,000 $ 120,000 $ 120,000 Total inflow
$ 21,888 $ 13,133 $ 7,880 $ -
$ 98,112 $ 106,867 $ 112,120 $ - D. TIME LINE OF THE RELEVANT CASH FLOWS
$ 39,245 $ 42,747 $ 44,848 $ - New Machine
$ 58,867 $ 64,120 $ 67,272 $ -
$ 21,888 $ 13,133 $ 7,880 $ -
$ 80,755 $ 77,253 $ 75,152 $ - $ 24,560 $ 17,832

$ 95,000 $ 95,000 $ 95,000 0

$ 6,000 1 2
$ 89,000 $ 95,000 $ 95,000 $ - End of year
$ 35,600 $ 38,000 $ 38,000 $ - $ 122,080
$ 53,400 $ 57,000 $ 57,000 $ - (initial investment)
$ 6,000 $ - $ - $ -
$ 59,400 $ 57,000 $ 57,000 $ -
 New Machine
sale of proposed machine
f proposed machine $ 24,000
ed machine $ 1,672
oceeds—proposed $ 22,328
sale of present machine
f present machine $ 8,000
$ 3,200
oceeds—present $ 4,800
$ 18,000
$ 35,528

$ 18,152
$ 35,528
$ 53,680

ANT CASH FLOWS

$ 18,152 Operating cash flow

$ 35,528 Terminal cash flow
$ 21,355 $ 20,253 $ 53,680 Total Cash Flow

3 4 5
End of year