Timber Products Incorporated is considering two alternative investments. One inv

Question

Timber Products Incorporated is considering two alternative investments. One investment is purchasing a heavy duty set of tools for Timber Cutting (Saws, Power Supplies...).The cost is 200,000 dollars. The plan is to keep the equipment for ten years and then sell it for its Salvage Value of 20,000 dollars. The generated revenue after expenses will be 80,000 dollars for each of the ten years before tax cash flow. The alternative investment is in Fencing and Landscaping for the Central Office. The cost is 180,000 and the expected before tax cash flow would be 70,000 dollars after expenses since customer relations would improve with an improved corporate image. The landscaping would last 20 years. Salvage value is negligible in this case. The period of comparison will be 7 years for the two choices. Show a full analysis of the yearly tax implications of each choice including depreciation, taxable income, taxes and after tax cash flow all for the seven years. Use the MACRS method of depreciation. Use present worth for the first seven years as the criteria for choosing. Income tax rate is 40%.

Explanation / Answer

Investment 2 is preferable as it has more cash flows when compared to Investment 1.

Workings:

Investment 1 Year Cash Flows Depreciation Taxable Income Taxes After Tax cash flows 1 80,000 20,000 60,000 24,000 36,000 2 80,000 36,000 44,000 17,600 26,400 3 80,000 28,800 51,200 20,480 30,720 4 80,000 23,040 56,960 22,784 34,176 5 80,000 18,440 61,560 24,624 36,936 6 80,000 14,740 65,260 26,104 39,156 7 80,000 13,100 66,900 26,760 40,140 After tax Cash flow at the end of 7 years 243,528

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