Reference no: EM13903266

Deriving cash flows for abandonment decision. The Tiny Treasures Company must decide whether to continue selling a line of children's shoes manufactured on a machine that has no other purpose. The machine has a current book value of $12,000, and Tiny Treasures can sell it today for $8,000. Tiny Treasures depreciates the machine on a straight-line basis for tax purposes assuming no salvage value and could continue to use it four more years. If Tiny Treasures keeps the machine in use, it can sell it at the end of four years for $800, although this will not affect the depreciation charge for the next four years. The variable cost of producing a pair of shoes on the machine is less than the cash received from customers by 000 per year. To produce and sell the children's shoes requires cash outlays of $10,000 per year for administrative and overhead expenditures as well. Tiny Treasures Company pays taxes at a rate of 40 percent. The rate applies to any gain or loss on disposal of the machine as well as to other income. From its other activities, Tiny Treasures Company earns more income than any losses from the line of children's shoes or from disposal of the machine.

a. Prepare a schedule showing all the cash and cost flows that Tiny Treasures Company needs to consider in order to decide whether to keep the machine.

b. Should Tiny Treasures Company keep the machine if its cost of capital is 12 percent?

c. Repeat part b. assuming a cost of capital of 20 percent.