Lander Company has an opportunity to pursue a capital budgeting project with a f
ID: 2528406 • Letter: L
Question
Lander Company has an opportunity to pursue a capital budgeting project with a five-year time horizon. After careful study, Lander estimated the following costs and revenues for the project:
The piece of equipment mentioned above has a useful life of five years and zero salvage value. Lander uses straight-line depreciation for financial reporting and tax purposes. The company’s tax rate is 40% and its after-tax cost of capital is 12%. When the project concludes in five years the working capital will be released for investment elsewhere within the company
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. Calculate the annual income tax expense for each of years 1 through 5 that will arise as a result of this investment opportunity.
2. Calculate the net present value of this investment opportunity. (Negative amounts should be indicated by a minus sign. Round your final answer to nearest whole dollar.)
Cost of equipment needed $ 280,000 Working capital needed $ 65,000 Repair the equipment in two years $ 20,500 Annual revenues and costs: Sales revenues $ 400,000 Variable expenses $ 205,000 Fixed out-of-pocket operating costs $ 90,000Explanation / Answer
1 Year 1 Year 2 Year 3 Year 4 Year 5 Sales (A) 400000 400000 400000 400000 400000 Less: costs Variable expenses 205000 205000 205000 205000 205000 Fixed out-of-pocket operating costs 90000 90000 90000 90000 90000 Repairs 0 20500 0 0 0 Depreciation (280000/5) 56000 56000 56000 56000 56000 Total (B) 351000 371500 351000 351000 351000 Income before taxes (A-B) 49000 28500 49000 49000 49000 Annual income tax expenses @ 40% 19600 11400 19600 19600 19600 2 Net present value Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Income before taxes 49000 28500 49000 49000 49000 Less: Annual income tax expenses 19600 11400 19600 19600 19600 Net income 29400 17100 29400 29400 29400 Add: depreciation 56000 56000 56000 56000 56000 Annual cash inflow 85400 73100 85400 85400 85400 Initial investment -280000 Working capital -65000 65000 Net cashflow -345000 239400 186100 239400 239400 304400 Discount factor @12% 1 0.892857 0.797194 0.71178 0.635518 0.567427 Discounted cashflow -345000 213750 148358 170400 152143 172725 Net present value 512376
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