Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $3,000 and sell its old washer for $800. The new washer will last for 6 years and save $600 a year in expenses. The opportunity cost of capital is 9%, and the firm’s tax rate is 21%. a. If the firm uses straight-line depreciation over a 6-year life, what are the cash flows of the project in years 0 to 6? The new washer will have zero salvage value after 6 years, and the old washer is fully depreciated.

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thanhtrungftu02 thanhtrungftu02 · Answer 1 · 2019-11-07T18:42:33+01:00

Answer:

Casflow at t = 0: - 3,000 + 800 - (800 - 0) x 21% = $-2,368.

Cashflows from t = 1 to t = 5: 600 x (1 - 21%) + (3,000/6) = $974.

Casflow at t = 6: 600 x (1 - 21%) + (3,000/6) + 0 = $974.

Explanation:

Cashflows of a project include three parts:

Initial outlay (at t = 0): equal to initial investment - cash inflow from sales of old asset (net of captial gain tax)

Operating cashflow (from t = 1 to t = 6): EBIT x (1 - Tax rate) + NCC - WCInv - FCInv, where:

EBIT: Earnings before interest & tax

NCC: Non-cash charges (depreciation is the most common item).

WCInv: Working captial investment

FCInv: Fixed captital invesment.

Salvage value (at t = 6): funded from liquidating assets at the end of the project.

Putting all the numbers together, we have:

Casflow at t = 0: - 3,000 + 800 - (800 - 0) x 21% = $-2,368.

Cashflows from t = 1 to t = 5: 600 x (1 - 21%) + (3,000/6) = $974.

Casflow at t = 6: 600 x (1 - 21%) + (3,000/6) + 0 = $974.