Rockyford Company must replace some machinery that has zero book value and a current market value of $1,800. One possibility is toinvest in new machinery costing $40,000. This new machinery would produce estimated annual pretax cash operating savings of$12,500. Assume the new machine will have a useful life of 4 years and depreciation of $10,000 each year for book and tax purposes.It will have no salvage value at the end of 4 years. The investment in this new machinery would require an additional $3,000investment of net working capital. (Assume that when the old machine was purchased, the incremental net working capital required atthe time was $0.)If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur onDecember 31 of this year. The cash flows from the investment are expected to occur over a four-year period.Rockyford is subject to a 40% income tax rate for all ordinary income and capital gains and has a 10% weighted-average after-tax costof capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from AppendixC-Table 1 or Table 2.)Required:1. What is the after-tax cash flow arising from disposing of the old machinery?2. What is the present value of the after-tax cash flows for the next 4 years attributable to the cash operating savings?3. What is the present value of the tax-shield effect of depreciation expense for year 1?4. Which one of the following is the proper treatment for the additional $3,000 of net working capital required in the current year?

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Asked Nov 17, 2019
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Rockyford Company must replace some machinery that has zero book value and a current market value of $1,800. One possibility is to
invest in new machinery costing $40,000. This new machinery would produce estimated annual pretax cash operating savings of
$12,500. Assume the new machine will have a useful life of 4 years and depreciation of $10,000 each year for book and tax purposes.
It will have no salvage value at the end of 4 years. The investment in this new machinery would require an additional $3,000
investment of net working capital. (Assume that when the old machine was purchased, the incremental net working capital required at
the time was $0.)
If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on
December 31 of this year. The cash flows from the investment are expected to occur over a four-year period.
Rockyford is subject to a 40% income tax rate for all ordinary income and capital gains and has a 10% weighted-average after-tax cost
of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix
C-Table 1 or Table 2.)
Required:
1. What is the after-tax cash flow arising from disposing of the old machinery?
2. What is the present value of the after-tax cash flows for the next 4 years attributable to the cash operating savings?
3. What is the present value of the tax-shield effect of depreciation expense for year 1?
4. Which one of the following is the proper treatment for the additional $3,000 of net working capital required in the current year?
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Rockyford Company must replace some machinery that has zero book value and a current market value of $1,800. One possibility is to invest in new machinery costing $40,000. This new machinery would produce estimated annual pretax cash operating savings of $12,500. Assume the new machine will have a useful life of 4 years and depreciation of $10,000 each year for book and tax purposes. It will have no salvage value at the end of 4 years. The investment in this new machinery would require an additional $3,000 investment of net working capital. (Assume that when the old machine was purchased, the incremental net working capital required at the time was $0.) If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment are expected to occur over a four-year period. Rockyford is subject to a 40% income tax rate for all ordinary income and capital gains and has a 10% weighted-average after-tax cost of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix C-Table 1 or Table 2.) Required: 1. What is the after-tax cash flow arising from disposing of the old machinery? 2. What is the present value of the after-tax cash flows for the next 4 years attributable to the cash operating savings? 3. What is the present value of the tax-shield effect of depreciation expense for year 1? 4. Which one of the following is the proper treatment for the additional $3,000 of net working capital required in the current year?

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Step 2

We have assumed the current year as Year 0, Year 1 as the end of first year of installing machine and so forth.

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1 After tax cash flow from disposing of the old machinery Market Value of the machinery less Tax @40 % After tax cash inflow from disposing the machinery $ 1800 -720 1080

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End of Year 1 End of Year 2 End of Year 3 End of Year 4 Total 2 Cash operating savings Operating savings Less Tax @40% Operating savings post tax 12500 12500 12500 12500 50000 -5000 -5000 -5000 -5000 -20000 7500 7500 7500 7500 30000 PV of $1 after end of year @10% discount rate Pv of operating savings 0.9091 0.8264 0.7513 0.6830 23774 6818 6198 5635 5123

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