The PARC Co. Inc. asked you to determine some of the after-tax cash flows for eq

ID: 1100244 • Letter: T

Question

The PARC Co. Inc. asked you to determine some of the after-tax cash flows for equipment used for research and development that is being considered. PARC expects the equipment to operate for five years and to require the purchase of $250,000 worth of capital equipment.

The capital equipment will have a resale value of $100,000 at the end of the five years.

PARC plans to use a 5-year MACRS depreciation schedule for income tax calculations.

The income tax rate is 35%, and PARC uses an after-tax MARR of 12%.

The equipment results in an increase in PARC's before-tax annual income of $45,000.

Determine if it is worth investing on this equipment.

A. Invest B. Do not invest

Explanation / Answer

Initial Investment = $250,000

Increase in before tax income from year 1 to year 5 = $45,000

Five year MACRS depreciation rates: - 20.00% , 32.00% , 19.20% , 11.52% , 11.52% , 5.76%

Calculation of free cash flow from year 1 to year 5:

Year

Increase in net income before tax

45000

Less: Depreciation

-50000

-80000

-48000

-28800

Before Tax Increase in income

-5000

-35000

-3000

16200

Less: Tax @ 35%

1750

12250

1050

-5670

After tax increase in income

-3250

-22750

-1950

10530

Add: Depreciation

50000

80000

48000

28800

Cash generated from operations

46750

57250

46050

39330

Book value at the end of five years = Purchase cost