MS Trucking is considering the purchase of a new piece of equipment that has a net initial investment with a present value of $300,000. The equipment has an estimated useful life of3years. For tax purposes1 the equipment will be fully depreciated a rates of 30%, 40%, and 30% in years one, two, and three, respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax rate and a 16% cost of capital. Discount rates for a 16% rate are:Assume that the salvage value at the end of the investment's useful life is zero. What is the new payback period?
Answer(s): D
The payback period is the time required to recover the original investment. As determined below, the annual net after-tax cash inflows for Years 1 through 3 are $138,000, $150,000, and $138,000 (excluding salvage value), respectively. In Year 1, the after-tax cash inflow is $170,000 minus taxes of $32,000 {[$1 70,000 -- ($300,000 x 30%) depreciation] x 40%}, or $138,000. In Year 2, the after-tax cash inflow is $170,000 minus taxes of $20,000 {[$1 70,000 -- $300,000 x 40%) depreciation] x 40%}, or $150,000. In Year 3, the after-tax cash inflow I(excluding salvage value) is again $138,000. After 2 years, $288,000 ($138,000 + $150,000) will have been `recovered. Consequently, the first $12,000 received in Year 3 will recoup the initial investment.Because $12,000 represents .09 (rounded) of Year 3 net after4ax cash inflows ($12,000 + $138,000), the payback period is 2.09 years.
MS Trucking is considering the purchase of a new piece of equipment that has a net initial investment with a present value of $300,000. The equipment has an estimated useful life of3years. For tax purposes1 the equipment will be fully depreciated a rates of 30%, 40%, and 30% in years one, two, and three, respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax rate and a 16% cost of capital. Discount rates for a 16% rate are:What is the net present value of this project?
Answer(s): B
The NPV is the excess of the present values of the estimated net cash inflows over the net cost of the investment ($160,000). The future cash inflows consist of $85,000 per year savings minus income taxes. Given salvage value of $10,000, the depreciable base is $150,000 ($160,000 cost -- $10,000). The first and third years' depreciation deduction is $45,000 ($150,000 x 30%), leaving $40,000 ($85,000--$45,000) of taxable income. Thus, first- and third-year tax expense is $16,000 ($40,000 x 40%). Accordingly, the net cash inflow in both the first and third years is $69,000 ($85,000 --$16,000). The $60,000 ($150,000 x 40%) depreciation deduction in the second year results in $25,000 ($85,000--$60,000) of taxable income. Second-year tax expense is therefore $10,000 ($25,000 x40%) and the second-year net cash inflow is $75,000 ($85,000--$10,000). The net cash inflow from sale of the machine is $10,000. No tax is paid on this amount because the remaining book value is also $10,000. The present value of these net cash inflows is determined using the appropriate PV of $1 factors for a hurdle rate of 16%. Hence, the net present value is $5,842 ($165,842 PV--$160,000 cost).
McLean, Inc. is considering the purchase of a new machine that will cost $160,000. The machine has an estimated useful life of 3 years. Assume that 30% of the depreciable base will be depreciated in the first year1 40% in the second year, and 30% in the third year. The new machine will have a $10000 resale value at the end of its estimated useful life. The machine is expected to save the company $85000 per year in operating expenses. McLean uses a 40% estimated income tax rate and a 16% hurdle rate to evaluate capital projects. Discount rates for a 16% rate are as follows:The payback period for this investment would be
Answer(s): C
The payback period is the number of years required for the cumulative undiscounted net cash inflows to equal the original investment. The future net cash inflows consist of $69,000 in Year 1 and 3, $75,000 in Year 2, and $10,000 upon resale. After 2 years, the cumulative undiscounted net cash inflow equals $144,000. Thus, $16,000 ($160,000 -- $144,000) is to be recovered in the Year 3, and payback should be complete in approximately 2.23 years [2 years + ($16,000 ÷ $69,000 net cash inflow in third year)]
A proposed investment is not expected to have any salvage value at the end of its 5-year life. Because of realistic depreciation practices, the net carrying amount and the salvage value are equal at the end of each year. For present value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% after-tax target rate of return.The accounting rate of return based on the average investment is
The accounting rate of return (the unadjusted rate of return or rate of return on the carrying amount) equals the increase in accounting net income divided by either the initial or the average investment. It ignores the time value of money. The average income over 5 years is $86,000 [($70,000 + $78,000 + $86,000 + $94000 + $102,000) + 5] Dividing the $86,000 average net income by the $250,000 average investment ($500,000 cost + 2) produces an accounting rate of return of 34.4%.
A proposed investment is not expected to have any salvage value at the end of its 5-year life. Because of realistic depreciation practices, the net carrying amount and the salvage value are equal at the end of each year. For present value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% after-tax target rate of return.The net present value is
The NPV method discounts the expected cash flows from a project using the required rate of return. A project is acceptable if its NPV is positive. Based on the interest factors for the present value of $1 at 12% and the annual after4ax cash flows, the NPV of the project over its 5-year life is
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