Question: 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

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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%.

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 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%.

REQUIRED:

Create a spreadsheet:

to calculate the initial investment.

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 that the present machine has only 3 years of depreciation remaining.

to calculate the operating cash flows for Damon corporation for both the proposed and the present machine.

to calculate the terminal cash flow associated with the project.

Question Data:

Original purchase price 3 years ago $120,000

Net selling price of the existing machine $70,000

Cost of new machine (including installation costs) $160,000

Installation costs $15,000

Salvage value of new machine (after 5 years) $24,000

Salvage value of existing machine (after 5 years) $8,000

Changes to working capital:

Increase in accounts receivable $15,000

Increase in inventory $19,000

Increase in account payable $16,000

EBDIT for the present machine next 5 years $95,000

EBDIT for the proposed machine for next five years:

1 $105,000

2 $110,000

3 $120,000

4 $120,000

5 $120,000

Tax 40%

Depreciation MACRS 5-year recovery

MACRS 5-year Table

Recovery year Percentage recovery

1 20%

2 32%

3 19%

4 12%

5 12%

6 5%