Tank Ltd is considering undertaking the purchase of a new piece of equipment tha

Question

Tank Ltd is considering undertaking the purchase of a new piece of equipment that is expected to increase pre-tax income(EBITDA) by $7,000 each year for the next 5 years. It costs $25,000 to purchase today and for tax purposes must be depreciated down zero over its 8 year useful life using the straight-line method. If Tank is actually forecasting a salvage (for capital budgeting purposes) of $8,000 after 5 years, what is the machine's net cash flow (after tax) for year 5? Assume the tax rate is 30%. NB: EBITDA is "Earnings Before Interest, Taxes, Depreciation and Amortisation"

$25,000

$14,250

$11,438

$13,838

Explanation / Answer

Net cash flow (after tax) for year 5 = 5837.50+8412.50

= $14,250

Working Note:

Step 1: Calculation of Cashflow After Tax( CFAT) form increase in income

Step 2: Calculation of CFAT from salvage

EBITDA               7,000 Less: Depreciation(25000/8)               3,125 EBIT               3,875 Less: Interest                      -   EBT               3,875 Less: Income Tax @30% 1,162.50 Net Income 2,712.50 Add: Depreciation               3,125 CFAT 5,837.50

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