You bought a survey device at $750,000 at beginning of year 1. You expect to use

Question

You bought a survey device at $750,000 at beginning of year 1. You expect to use it to generate an annual revenue of $350,000 for year 1 and increase at 4% per year. The operating expenses will be $ 120,000 for year 1 and increase at 3% per year. At end of year 3, you can sell the device for $300,000 and close the business. Assuming you will have an income tax rate of 30% every year and a capital gain tax rate of 15% at year 3 and you will take depreciation charge every year based on the MACRS schedule as follows:

Year 1            20%

Year 2            32%

Year 3            19.2%

Part 1

Assuming all cash investment and using a MARR of 12%, what is the Net Present Value of this 3-year business and what is the IRR? Show the results as formatted below:

1

                       2

3

Revenue

Operating Expense

EBITDA

Depreciation Charge

Taxable Income

Tax @30% tax rate

Net Income

CFAT

Also clearly show the calculations of each year’s Depreciation Charges, Cash Flow After Tax at Year 3 for selling of the device and calculations of the present value and IRR, separately.

Part 2

Assuming you will obtain a bank loan of $450,000 at an interest rate of 6% per year. The loan requires interest payment only at end of each year and the loan principle is due at end of the 3rd year (like a bond arrangement). Everything else stays the same as Part 1. Re-calculate everything as you did in Part 1.

Based on the result of Part 2, make your recommendation as which way to go, Part 1 or Part 2, and explain how financial leverage works?

1

                       2

3

Revenue

Operating Expense

EBITDA

Depreciation Charge

Taxable Income

Tax @30% tax rate

Net Income

CFAT

Explanation / Answer

For three Year MACR Rate 20 32 19.2 Depriciation Calculated on given rate (Machine value-salvage Value) Year 1 Year 2 Year 3 Cost of Machine $750,000.00 Revenue $350,000.00 $364,000.00 $378,560.00 Operating Expense $120,000.00 $123,600.00 $127,308.00 EBITDA $230,000.00 $240,400.00 $251,252.00 Depreciation Charge $90,000.00 $144,000.00 $86,400.00 Taxable Income $140,000.00 $96,400.00 $164,852.00 Tax @30% $42,000.00 $28,920.00 $49,455.60 Net Income $98,000.00 $67,480.00 $115,396.40 Salvage Value of machine $300,000.00 CFAT -$562,000.00 $211,480.00 $501,796.40 NPV @ 12 % $23,973.61

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