Chapter 8 - Pearson Learning Solutions

338 PART THREE Long-Term Investment DecisionsTABLE 8.6Depreciation Expense for Proposed and Present Machinesfor Powell CorporationApplicable MACRS depreciation DepreciationCost percentages (from Table 3.2) [(1)(2)]Year (1) (2) (3)With proposed machine1 $400,000 20% $ 80,0002 400,000 32 128,0003 400,000 19 76,0004 400,000 12 48,0005 400,000 12 48,0006 400,000520,000Totals 100%$400,000With present machine1 $240,000 12% (year-4 depreciation) $28,8002 240,000 12 (year-5 depreciation) 28,8003 240,000 5 (year-6 depreciation) 12,0004Because the present machine is at the end of the third year of its cost05 recovery at the time the analysis is performed, it has only the final 306Totalyears of depreciation (as noted above) still applicable.0$69,600aa The total $69,600 represents the book value of the present machine at the end of the third year,as calculated in the preceding example.The proposed machine is to be depreciated under MACRS using a 5-yearrecovery period. 6 The resulting depreciation on this machine for each of the6 years, as well as the remaining 3 years of depreciation (years 4, 5, and 6) on thepresent machine, are calculated in Table 8.6. 7The operating cash inflows each year can be calculated by using the incomestatement format shown in Table 8.7. Note that we exclude interest because weare focusing purely on the “investment decision.” The interest is relevant to the“financing decision,” which is separately considered. Because we exclude interestexpense, “earnings before interest and taxes (EBIT)” is equivalent to “net profitsbefore taxes,” and the calculation of “operating cash inflow” in Table 8.7 is equivalentto “operating cash flow (OCF)” (defined in Equation 3.4, on page 104).Simply stated, the income statement format calculates OCF.Substituting the data from Tables 8.5 and 8.6 into this format and assuming a40% tax rate, we get Table 8.8. It demonstrates the calculation of operating cash6. As noted in Chapter 3, it takes n 1 years to depreciate an n-year class asset under current tax law. Therefore,MACRS percentages are given for each of 6 years for use in depreciating an asset with a 5-year recovery period.7. It is important to recognize that although both machines will provide 5 years of use, the proposed new machinewill be depreciated over the 6-year period, whereas the present machine, as noted in the preceding example, has beendepreciated over 3 years and therefore has remaining only its final 3 years (years 4, 5, and 6) of depreciation (12%,12%, and 5%, respectively, under MACRS).2008935971Principles of Managerial Finance, Brief Fifth Edition, by Lawrence J. Gitman. Copyright © 2009 by Lawrence J. Gitman. Published by Prentice Hall.