Appendix 8C) Pont Corporation has provided the following information concerning

Question

Appendix 8C) Pont Corporation has provided the following information concerning a capital budgeting project: Investment required in equipment $160,000 Expected life of the project 4 Salvage value of equipment $0 Annual sales $470,000 Annual cash operating expenses $340,000 Working capital requirement $20,000 One-time renovation expense in year 3 $70,000 The company's income tax rate is 30% and its after-tax discount rate is 10%. The working capital would be required immediately and would be released for use elsewhere at the end of the project. The company uses straight-line depreciation on all equipment. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting. The income tax expense in year 2 is: $27,000 OR $21,000 OR $39,000 OR $6,000?

Explanation / Answer

1. Cash will be paid for Income tax in year 2 = $ 27000 (working as per Cash inflow from operation) 2. Net Present Value of the project Year 0 Year 1 Year 2 Year 3 Year 4 Initial Invenstment -160000 Working capital Requirement -20000 Cash Inflow          103,000          103,000            78,500            78,500 Realse of working capital            20,000 Cash flow from operation -180000 103000 103000 78500 98500 Discount factor @ 10% 1               0.909               0.826               0.751               0.683 Present Value of Cash flow         (180,000)            93,636            85,124            58,978            67,277 Net Present Value of the Project           125,015 * Cash inflow from operation Sales          470,000          470,000          470,000          470,000 Less:- Operating Exp          340,000          340,000          340,000          340,000 Less:- Depreciation            40,000            40,000            40,000            40,000 (160000/4) Less:- Rennovation Exp            35,000            35,000 Net Profit before tax            90,000            90,000            55,000            55,000 Less:- Tax @ 30%            27,000            27,000            16,500            16,500 Net Profit after tax            63,000            63,000            38,500            38,500 Cash inflow (profit+Dep)          103,000          103,000            78,500            78,500

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