To calculate the net cash flows for year 2, we need to consider the following components:
1. Depreciation expense:
Since the new baking line can be depreciated as a 7-year MACRS asset, we need to determine the depreciation amount for year 2 using the MACRS depreciation rates. The depreciation rate for year 2 under MACRS is 24.49%.
Thus, the depreciation expense for year 2 on the new baking line is 24.49% x $940,000 = $230,356.
2. Operating income:
Operating income is calculated by subtracting the operating expenses from the increased revenues.
Therefore, operating income for year 2 is $425,000 - $170,000 = $255,000.
3. Tax expense:
To calculate the tax expense, we need to determine the taxable income. Taxable income is calculated by subtracting the depreciation expense from the operating income and adding back the depreciation expense of the old machine.
Taxable income for year 2 is ($255,000 - $230,356) + $20,000 = $44,644.
The tax expense is then calculated as 40% of the taxable income, which is 0.4 x $44,644 = $17,858.
4. Net cash flows:
The net cash flows for year 2 is calculated by subtracting the tax expense from the sum of the operating income and the depreciation expense, and adding the proceeds from the sale of the old machine.
Net cash flows for year 2 is ($255,000 - $230,356) + $20,000 - $17,858 + $30,000 = $56,786.
Therefore, the net cash flows for year 2 is $56,786.