Schille Company is considering a $5.4 million asset investment that has a four-year service life and a $400,000 salvage value.The investment is expected to produce annual savings in cash operating costs of $860,000 and will require a $250,000 overhaul in year 3,which is fully-deductible for tax purposes.
Schille uses the net-present-value method to analyze investments.Asset investments are depreciated by the straight-line method,ignoring salvage values in related computations.
Required:
A.Asset acquisition: $(5,400,000)
Annual savings in cash operating costs: $860,000
Annual straight-line depreciation: $0
Year 3 overhaul: $(250,000)
Year 4 asset disposal: $400,000
A.Ignoring income taxes,determine the (pre-discounted)cash-flow amounts that would be used in a net-present-value analysis for (1)the asset acquisition,(2)annual savings in cash operating costs,(3)annual straight-line depreciation,(4)the overhaul in year 3,and (5)disposal of the asset in year 4.Note cash outflows in parentheses.
B.Asset acquisition: $(5,400,000)
Annual savings in cash operating costs: $860,000 * 0.7 = $602,000
Depreciation should be:
Year 1: $675,000 x.3 = $202,500
Year 2: $1,350,000 x.3 =$405,000
Year 3: $1,350,000 x.3 =$405,000
Year 4: $1,350,000 x.3 =$405,000
Year 5: $675,000 x.3 = $202,500
Year 3 overhaul: $(250,000)* 0.7 = $(175,000)
Year 4 asset disposal: $5,400,000 _- $5,400,000 accumulated depreciation = $0 book value;$0 book value _- $400,000 salvage value = $400,000 gain;$400,000 gain * 0.3 = $(120,000)added tax;$400,000 salvage value _- $(120,000)added tax = $280,000
B.Repeat requirement "A," assuming the company is subject to a 30% income tax rate.Assume the company depreciates the asset using the optional straight-line methoD.Additionally,it depreciates it over the asset's service life (not its MACRS life).

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