Child corporation projects gross cash flows directly resulting from the purchase

Question

Child corporation projects gross cash flows directly resulting from the purchase of the equipment:

Year 1 $285,000

Year 2 $350,000

Year 3 $290,000

Year 4 $275,000

Year 5 $255,000

Child corporation uses a time value of money rate of 9% for decision-making purposes. Assume the equipment is sold for the salvage value of $100,000 at the end of Year 5 (no taxable gain or loss from the disposal is reported).

A) Calculate the payback period of the investment in the equipment.

B) Calculate the net present value of the investment in the equipment.

C) Calculate the profitability index of the investment in the equipment.

Explanation / Answer

Answer:

(4th year depreciation is limited to $51,200 to limit the max depreciable value to $600,000.i.e 700,000-100,000)

Payback period =

Payback period = Year 2 + 130950/242700 = 2.54 years

2.

3.

Profitability index = NPV/Initial cash outflow = $343,121.24/700,000 = 49.02%

Less:Depreciation (PAT+Depreciation) Year Cash flows 2*(1/5)* beginning book value Profit before Tax Tax @25% Profit after tax CF after tax 1 285000 -280000 565000 141250 423750 143750 2 350000 -168000 518000 129500 388500 220500 3 290000 -100800 390800 97700 293100 192300 4 275000 -69760 344760 86190 258570 188810 5 255000 0 255000 63750 191250 191250

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