37. Morage Corp. is replacing an entire baking line that was purchased for $420,000 and currently has a book value of $60,000. The new, more efficient line, will cost $940,000 installed and can be depreciated as a 7-year MACRS asset. With the increased efficiency, Morage expects annual revenues to increase by $425,000, and operating expenses to increase by $170,000. The older machine, which was being depreciated at the straight-line rate of $20,000/year, will be sold for $30,000. What are the net cash flows for year 2? Assume the firm's marginal tax rate is 40% and that the year 2 depreciation rate is 24.49% under MACRS.
To calculate the net cash flows for year 2, we need to consider the following components:
1. Depreciation expense:
Since the new baking line can be depreciated as a 7-year MACRS asset, we need to determine the depreciation amount for year 2 using the MACRS depreciation rates. The depreciation rate for year 2 under MACRS is 24.49%.
Thus, the depreciation expense for year 2 on the new baking line is 24.49% x $940,000 = $230,356.
2. Operating income:
Operating income is calculated by subtracting the operating expenses from the increased revenues.
Therefore, operating income for year 2 is $425,000 - $170,000 = $255,000.
3. Tax expense:
To calculate the tax expense, we need to determine the taxable income. Taxable income is calculated by subtracting the depreciation expense from the operating income and adding back the depreciation expense of the old machine.
Taxable income for year 2 is ($255,000 - $230,356) + $20,000 = $44,644.
The tax expense is then calculated as 40% of the taxable income, which is 0.4 x $44,644 = $17,858.
4. Net cash flows:
The net cash flows for year 2 is calculated by subtracting the tax expense from the sum of the operating income and the depreciation expense, and adding the proceeds from the sale of the old machine.
Net cash flows for year 2 is ($255,000 - $230,356) + $20,000 - $17,858 + $30,000 = $56,786.
Therefore, the net cash flows for year 2 is $56,786.
To calculate the net cash flows for year 2, we need to consider the following:
1. Depreciation Expense:
The new baking line can be depreciated as a 7-year MACRS asset. The MACRS depreciation rate for year 2 is 24.49%. To calculate the depreciation expense for year 2, we multiply the depreciation rate by the cost of the new baking line:
Depreciation Expense = Depreciation Rate * Cost of New Baking Line
Depreciation Expense = 24.49% * $940,000
2. Revenue Increase:
The increased efficiency of the new baking line is expected to increase annual revenues by $425,000. To calculate the increase in revenue for year 2, we simply take the expected increase:
Revenue Increase = $425,000
3. Operating Expenses:
The increased efficiency of the new baking line is also expected to increase operating expenses by $170,000. To calculate the increase in operating expenses for year 2, we simply take the expected increase:
Operating Expense Increase = $170,000
4. Sale of Old Machine:
The old machine is being sold for $30,000. This results in a cash inflow of $30,000.
Now, let's calculate the net cash flows for year 2:
Net Cash Flow = (Revenue Increase - Operating Expense Increase) + Depreciation Expense + Sale of Old Machine - Tax
First, let's calculate the tax, which is based on the net taxable income. The net taxable income is calculated by subtracting the depreciation expense from the revenue increase:
Net Taxable Income = Revenue Increase - Depreciation Expense
Then, the tax is calculated by multiplying the net taxable income by the tax rate:
Tax = Net Taxable Income * Tax Rate
Tax = (Revenue Increase - Depreciation Expense) * 40%
Finally, we can calculate the net cash flows for year 2 by plugging in the values into the formula:
Net Cash Flow = (Revenue Increase - Operating Expense Increase) + Depreciation Expense + Sale of Old Machine - Tax
I will calculate the values and provide the final answer in the next response.