The Pukie-Duke Company asked you to determine some of the after-tax cash flows f
ID: 2647556 • Letter: T
Question
The Pukie-Duke Company asked you to determine some of the after-tax cash flows for equipment used for research and development that is being considered. PDC expects the experiment to operate for five years and to require the purchase of $300,000 worth of capital equipment. The capital equipment will have a resale value of $100,000 at the end of the five years.
Pukie-Duke has found a company that will make them a $200,000 loan for the equipment at 10% and 4 years and they want to finance the equipment if possible.
Pukie-Duke plans to use MACRS depreciation schedule (three year life) for income tax calculations. The income tax rate is 35%, capital gains are taxed at 21%, and Pukie-Duke uses an after tax MARR of 12%.
It turns out that due to them being in the green energy program they can get a 10% tax credit for new investment in equipment. But it will require the purchase of an additional two acres of land for $60,000 and the building of an explosion proof room that will cost $220,000 to be constructed but can be sold back to the original landowner for the ending book value of the land and building at the end of the five years. Assume that the building and land are purchased in January of the first year and sold in December of the 5th year. PDC wants to be a good citizen and evaluate this total alternative of equipment, building and land.
The new equipment results in an increase in Pukie-Duke's before-tax annual net income of $145,000, find if it is worth investing on this equipment.
Explanation / Answer
Under the MACRS 3 year depreciation schedule, 200% declining method will be used. For MACRS depreciation, salvage value is ignored, and the applicable rates for the 1st 4 years are: 33.33%, 44.45%, 14.81% and 7.41% respectively.
Depreciation table:
Resale of equipment at 100,000 will attract 21% capital gain tax = 21,000. Net resale value = 79,000
Loan amount = 200,000 Tenure = 4 years Interest = 10%. It is assumed that 50,000 will be paid each year at the end of the year.
Calculation of interest:
Calculation of year-wise cash flows:
The rate which will make the PV of initial cash flow equal to PV of cash flows of year 1 to 5
-380,000 = -32,868.15/(1+r)^1-53,350/(1+r)^2............. +458,325/(1+r)^5
Using MARR of 1.12 %, sum of PV of cash flows from year 1 to 5 (as shown above) is $216,252 which is greater than the initial cash flow of -380,000 in the beginning of year 1. Thus the project is worth investing.
Year Rate Depreciation amount 1 0.3333 99,990 2 0.4445 133,350 3 0.1481 44,430 4 0.0741 22,230 Total 300,000Related Questions
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