Problem 1

Use the following information to calculate the answers to Problems 1 and 2:

You have been asked to render an opinion to your boss as to whether your employer should enter into the short-term capital project described below. The project requires the purchase of a new piece of equipment for a price of $25,000. The firm has paid a consultant $1,000 to estimate the revenues expected from the project. The firm that ships the equipment and installs it in our plant will charge $500.The projects incremental operating cash flows before taxes will be $12,000 per year for three years. At the end of three years, the equipment will be sold for $5000. The equipment has a three-year useful life and will be depreciated using the three-year MACRS depreciation schedule. (33.3%, 44.5%, 14.8%, 7.4%) The tax rate is 34% and the firms required rate of return is 17%.

a. What is the tax basis for the equipment?

b. What are the depreciation deductions for years 1, 2, and 3?

c. What will be the after-tax net cash flow from the sale of the asset at the end of year three?

d. Calculate the total operating cash flow for each of the three years counting the initial investment and the resale of the old equipment after year 3.