The president of Lowell Inc. has asked you to evaluate the proposed acquisition of a new...

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The president of Lowell Inc. has asked you to evaluate theproposed acquisition of a new computer. The computer's price is$60,000, and it falls into the MACRS 3-year class (33% in year 1,45% in year 2, 15% in year 3, and 7% in year 4). Purchase of thecomputer would require an increase in net operating working capitalof $2,000. The computer would increase the firm's before-taxrevenues by $20,000 per year but would also increase operatingcosts by $5,000 per year. The computer is expected to be used for 4years and then be sold for $25,000. The firm's marginal tax rate is40 percent, and the project's cost of capital is 14 percent. Whatis the total value of the terminal year non-operating cash flows(after-tax salvage value + working capital recovered) at the end ofYear 4?
a.
$17,000
b.
$18,680
c.
$21,000
d.
$25,000
e.
$27,000

Answer & Explanation Solved by verified expert

4.4 Ratings (813 Votes)

A)The book value of asset at end of year 4 will be 0 (fully depreciated )

Gain on sale =Sale value -book value

= 25000 - 0

= $ 25000

Tax on Gain on sale of asset = Gain on sale *tax rate

= 25000* 40%

= $ 10000

After tax sale value =sale value -Tax on gain on sale of asset

= 25000-10000

= 15000

So,

Non operating cash flow or Terminal value at year 4 =After tax sale value +working capital released

= 15000 + 2000

= $ 17000

correct option is "a" - 17000

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Transcribed Image Text

The president of Lowell Inc. has asked you to evaluate theproposed acquisition of a new computer. The computer's price is$60,000, and it falls into the MACRS 3-year class (33% in year 1,45% in year 2, 15% in year 3, and 7% in year 4). Purchase of thecomputer would require an increase in net operating working capitalof $2,000. The computer would increase the firm's before-taxrevenues by $20,000 per year but would also increase operatingcosts by $5,000 per year. The computer is expected to be used for 4years and then be sold for $25,000. The firm's marginal tax rate is40 percent, and the project's cost of capital is 14 percent. Whatis the total value of the terminal year non-operating cash flows(after-tax salvage value + working capital recovered) at the end ofYear 4?a.$17,000b.$18,680c.$21,000d.$25,000e.$27,000