Q.#1 What is the estimated annual change to Year 1-n cash flow due to depreciati

Question

Q.#1    What is the estimated annual change to Year 1-n cash flow due to depreciation from a capital budgeting investment costing $100,000 with a useful life of 12 years and a salvage value of $28,000? Assume a 34% tax rate and straight-line depreciation.

Q.2 A permanent working capital investment of $60,000 is expected to produce an annual after-tax cash inflow of $18,000 for many years and has a cost of capital of 12%. Calculate the net annual benefit of the proposed permanent working capital investment.

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part 1:

You will have to calculate the benefit (tax saving) resulting from depreciation.

Annual Depreciation = (Cost - Salvage Value)/Estimated Life = (100000 - 28000)/12 = 6000

Tax Saving = Annual Depreciation*Tax Rate = 6000*34% = 2040

Answer is $2040.

Part B:

It is a case of perptuity since the number of Years have not been provided.

Net Annual Benefit of the Proposed Investment = -Working Capital Investment + Present Value of Cash Inflows = - 60000 + 18000/(.12) = 90000

Answer is $90000

Thanks.

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