A freight company purchased new tractors &trailers; for $250,000 and expects thi

Question

A freight company purchased new tractors &trailers; for $250,000 and expects this investment to realize a net gross income over operating expenses of $80,000 for each of the next 5 years. The accountant for the company allows for an 18% MARR. The company's annual income is such that it is in the 35% tax bracket. The accountant also suggests that inflation be included in any economic analysis and that it be based upon the economy's inflation rate between the years 2001- 2008. The IRS requires this business to use MACRS for its depreciation schedule. (a) Determine the after-tax cash flow (constant dollars). (b) What is the total tax paid? (NOTE: specify if nominal or constant.) (c) Construct a complete (i.e, showing all pertinent CFD components) after-tax cash flow diagram (d) Perform an engineering economic analysis to determine if the purchase of the trailers is economically attractive after taxes & inflation (constant dollars). Clearly state the decision.

Explanation / Answer

All calculations are provided below. We have assumed that the net gross income of USD 80000 expected to be earned every year already takes into account MACRS depreciation (in operating expenses) and hence, we have not considered depreciation separately.

a. After tax cash flows for years 1 to 5 stand at USD 102000, 132000, 100000, 80800 and 80800 respectively.

b. Total tax paid for years 1 to 5 stands at USD 140000 i.e. USD 28000 for each of the 5 years. (i.e 35% on USD 80000 yearly)

c. Complete after tax cash flow calculation / diagram is provided below:

0 1 2 3 4 5 6 Investment -250000 Gross income (after all expenses including depreciation) 80000 80000 80000 80000 80000 Less: Tax @ 35% 28000 28000 28000 28000 28000 Net income after tax 52000 52000 52000 52000 52000 Add: MACRS Depreciation 50000 80000 48000 28800 28800 14400 After tax cash flows (A) -250000 102000 132000 100000 80800 80800 PV factors @ 18% MARR (B) 1 0.847458 0.718184 0.608631 0.515789 0.437109 PV of cash flows (A*B) -250000 86440.68 94800.34 60863.09 41675.74 35318.42

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