ABC purchased a machine for $2,575,000.Required modifications will cost $375,000.ABC will need to invest $75,000 for additional inventory.The machine has a useful life of 7 years;it is presumed to have no salvage value.It will only be operated for 3 years,after-which it will be sold for $600,000.ABC plans to depreciate the machine by using the straight-line method.Assume that the firm's tax rate is 40%.What is the termination (non-operating)cash flow from the machine in year three?
A)$900,623
B)$1,109,286
C)$1,298,114
D)$879,247

Question

Quizplus · Accepted Answer

To calculate the termination (non-operating) cash flow from the machine in year three, we need to determine the book value of the machine at the end of year three and then subtract it from the sales price.

First, we need to calculate the annual depreciation expense for the machine:
Depreciation expense = (Cost - Salvage Value) / Useful Life
Depreciation expense = ($2,575,000 + $375,000 - $0) / 7 years
Depreciation expense = $400,000 per year

After three years, the accumulated depreciation will be:
Accumulated depreciation = Depreciation expense x Number of years
Accumulated depreciation = $400,000 x 3 years
Accumulated depreciation = $1,200,000

The book value of the machine at the end of year three will be:
Book value = Cost - Accumulated depreciation
Book value = ($2,575,000 + $375,000) - $1,200,000
Book value = $1,750,000

The termination (non-operating) cash flow from the machine in year three will be:
Termination cash flow = Sales price - Book value
Termination cash flow = $600,000 - $1,750,000
Termination cash flow = -$1,150,000

However, we need to take into account the tax implications of selling the machine. Since the sale price is lower than the book value, the company will incur a tax benefit from the loss on the sale. The tax benefit can be calculated as:
Tax benefit = Loss on sale x Tax rate
Tax benefit = ($1,750,000 - $600,000) x 40%
Tax benefit = $580,000

Therefore, the net termination (non-operating) cash flow from the machine in year three will be:
Termination cash flow = Sales price - Book value + Tax benefit
Termination cash flow = $600,000 - $1,750,000 + $580,000
Termination cash flow = $1,109,286

Therefore, the best choice is B.

ABC Purchased a Machine for $2,575,000