Question 2: A project will require the investment of $108,000 in equipment (sum-

Question

Question 2: A project will require the investment of $108,000 in equipment (sum-of-years' -digits depreciation with a depreciable life of 8 years and zero salvage value) and $25,000 in raw materials (not depreciable). The annual project income after all expenses except depreciation have been paid is projected to be $24,000. At the end of 8 years the project will be discontinued and the $25,000 investment in raw materials will be recovered. Assume a 34% income tax rate for this corporation. The corporation wants a 15% after-tax rate of return on its investments. Determine by present worth analysis whether this project should be undertaken

Explanation / Answer

Answer:

Year

initial investment

Raw Material

Depreciation

Net annual project income before-tax depreciation

Tax Rate

Net annual project income after-tax depreciation

Net annual cash flow including depreciation

Recovery of investment in raw material

0

108000

25000

1

13500

24000

34%

6930

20430

2

13500

24000

34%

6930

20430

3

13500

24000

34%

6930

20430

4

13500

24000

34%

6930

20430

5

13500

24000

34%

6930

20430

6

13500

24000

34%

6930

20430

7

13500

24000

34%

6930

20430

8

13500

24000

34%

6930

20430

25000

yearly Depreciation (straight line method) = Investment / No. of years = 108000/8 = $13500

Net annual project income after-tax depreciation = (net annual income before tax and depreciation   - Depreciation )*(1-Tax rate) = (24000 - 13500)*(1-34%) = 6930

Net annual cash flow including depreciation (NCF) = (Net annual project income after-tax depreciation + Depreciation) = 6930+13500 = $20430

Net present value of project = present value of net annual cash flows including depreciation + present value of recovery amount of raw material - initial investment

if rate of return (R) = 15%

Net present value of project =NCF1/(1+R) + NCF2/(1+R)^2 + NCF3/(1+R)^3 + NCF4/(1+R^4 + NCF5/(1+R)^5 + NCF6/(1+R)^6 + NCF7/(1+R)^7 + NCF8/(1+R)^8 + 25000/(1+R)^8 - 108000

Net present value of project = 20430/1.15 + 20430/1.15^2 + 20430/1.15^3 + 20430/1.15^4 + 20430/1.15^5 + 20430/1.15^6 + 20430/1.15^7 + 20430/1.15^8 + 25000/1.15^8 - 108000

Net present value of project = -$8151.48

Here, NPV of the project is negative , it means that undertaking the project should incur net loss of $8151.48.

in this scenario, this project should not be undertaken.

Year

initial investment

Raw Material

Depreciation

Net annual project income before-tax depreciation

Tax Rate

Net annual project income after-tax depreciation

Net annual cash flow including depreciation

Recovery of investment in raw material

0

108000

25000

1

13500

24000

34%

6930

20430

2

13500

24000

34%

6930

20430

3

13500

24000

34%

6930

20430

4

13500

24000

34%

6930

20430

5

13500

24000

34%

6930

20430

6

13500

24000

34%

6930

20430

7

13500

24000

34%

6930

20430

8

13500

24000

34%

6930

20430

25000

yearly Depreciation (straight line method) = Investment / No. of years = 108000/8 = $13500

Net annual project income after-tax depreciation = (net annual income before tax and depreciation   - Depreciation )*(1-Tax rate) = (24000 - 13500)*(1-34%) = 6930

Net annual cash flow including depreciation (NCF) = (Net annual project income after-tax depreciation + Depreciation) = 6930+13500 = $20430

Net present value of project = present value of net annual cash flows including depreciation + present value of recovery amount of raw material - initial investment

if rate of return (R) = 15%

Net present value of project =NCF1/(1+R) + NCF2/(1+R)^2 + NCF3/(1+R)^3 + NCF4/(1+R^4 + NCF5/(1+R)^5 + NCF6/(1+R)^6 + NCF7/(1+R)^7 + NCF8/(1+R)^8 + 25000/(1+R)^8 - 108000

Net present value of project = 20430/1.15 + 20430/1.15^2 + 20430/1.15^3 + 20430/1.15^4 + 20430/1.15^5 + 20430/1.15^6 + 20430/1.15^7 + 20430/1.15^8 + 25000/1.15^8 - 108000

Net present value of project = -$8151.48

Here, NPV of the project is negative , it means that undertaking the project should incur net loss of $8151.48.

in this scenario, this project should not be undertaken.

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.