You have been asked to render an opinion to your boss as to whether your employer should enter into the short-term capital project described below.
The project requires the purchase of a new piece of equipment for a price of $25,000. The firm has paid a consultant $1,000 to estimate the revenues expected from the project. The firm that ships the equipment and installs it in our plant will charge $500.
The project's incremental operating cashflows before taxes will be $12,000 per year for three years. At the end of three years the equipment will be sold for $5000. The equipment has a three-year useful life and will be depreciated using the three-year MACRS depreciation schedule (assume these depreciation percentages: Yr 1: 33.3%, Yr 2: 44.5%, Yr 3: 14.8%, and Yr 4: 7.4%). The tax rate is 34% and the firm's required rate of return is 17%.
What is the depreciation basis for the equipment?
What will be the after-tax net cash flow from the sale of the asset at the end of year three?