A $20,000 investment in machinery is under consideration. The project is ex- pec
ID: 1122091 • Letter: A
Question
A $20,000 investment in machinery is under consideration. The project is ex- pected to have a life of 6 years and no salvage value. The estimated annual irn come from the project is $10,000 with annual operating expenses of $4,000 The investment will be depreciated by the MACRS (GDS) straight-line method based on a 5-year recovery period. If a 40% income tax rate is applied with a MARR of 5%, compute the present worth on the proposed investment's after- tax cash flow under the following financial policies: 22. he investment is provided from the firm's retained earnings The initial investment is borrowed at 10% with repayment of interest at the end of each period and repayment of the loan principal at the end of 5 years Repeat parts (a) and (b) for a MARR of 9% b, c.Explanation / Answer
Answer:
If investment is made from retained earnings, we will have full initial cash outflow in year 0, no interest charges. But, if loan is taken Cash outflow will be yearly interest for the loan period and principal repayment at the end of 5th year. We will caclulate Present Worth based on discounted value of each cash inflows and outflows in different scenarios (a), (b) and (c), adjusted with the tax shield amount.
Depreciation will be common in all the scenario's as follow:
Depreciation calculation based on 5-year recovery (MACRS), Investment Value $20,000
Recovery %
Depreciation
1
20%
$4,000
2
32%
$6,400
3
19.20%
$3,840
4
11.52%
$2,304
5
11.52%
$2,304
6
5.76%
$1,152
100%
$20,000
(a) Present Worth $5,269, refer below table for detailed calculation: MARR 5%
Year
Initial Investment
(A)
Annual Income
(B)
Operating Expenses
(C)
Depreciation
(D)
Gross Income
(E=B-C-D)
Tax shield @ 40%
(F=E*40%)
Net Income
(G=E-F)
Net Cash Flow
(H=A+G+D)
DCF @ 5%
(I)
NPV
(H*I)
0
-$20,000
-
-
-
-
-
-
-$20,000
1.0000
-$20,000
1
-
$10,000
$4,000
$4,000
$2,000
$800
$1,200
$5,200
0.9524
$4,952
2
-
$10,000
$4,000
$6,400
-$400
-$160
-$240
$6,160
0.9070
$5,587
3
-
$10,000
$4,000
$3,840
$2,160
$864
$1,296
$5,136
0.8638
$4,437
4
-
$10,000
$4,000
$2,304
$3,696
$1,478
$2,218
$4,522
0.8227
$3,720
5
-
$10,000
$4,000
$2,304
$3,696
$1,478
$2,218
$4,522
0.7835
$3,543
6
-
$10,000
$4,000
$1,152
$4,848
$1,939
$2,909
$4,061
0.7462
$3,030
Total
$5,269
(b) Present Worth $4,403, refer below table for detailed calculation: MARR 5%
Year
Loan Repayment
(A)
Annual Income
(B)
Operating Expenses
(C)
Interest Expenses
(D)
Depreciation
(E)
Gross Income
(F=B-C-D-E)
Tax shield @ 40%
(G=F*40%)
Net Income
(H=F-G)
Net Cash Flow
(I=A+H+E)
DCF @ 5%
(J)
NPV
(I*J)
0
-
-
-
-
-
-
-
-
-
1.0000
-
1
-
$10,000
$4,000
$2,000
$4,000
$0
$0
$0
$4,000
0.9524
$3,810
2
-
$10,000
$4,000
$2,000
$6,400
-$2,400
-$960
-$1,440
$4,960
0.9070
$4,499
3
-
$10,000
$4,000
$2,000
$3,840
$160
$64
$96
$3,936
0.8638
$3,400
4
-
$10,000
$4,000
$2,000
$2,304
$1,696
$678
$1,018
$3,322
0.8227
$2,733
5
-$20,000
$10,000
$4,000
$2,000
$2,304
$1,696
$678
$1,018
-$16,678
0.7835
-$13,068
6
-
$10,000
$4,000
-
$1,152
$4,848
$1,939
$2,909
$4,061
0.7462
$3,030
Total
$4,403
(c1) Present Worth $2,485, refer below table for detailed calculation: MARR 9%
Year
Initial Investment
(A)
Annual Income
(B)
Operating Expenses
(C)
Depreciation
(D)
Gross Income
(E=B-C-D)
Tax shield @ 40%
(F=E*40%)
Net Income
(G=E-F)
Net Cash Flow
(H=A+G+D)
DCF @ 9%
(I)
NPV
(H*I)
0
-$20,000
-
-
-
-
-
-
-$20,000
1.0000
-$20,000
1
-
$10,000
$4,000
$4,000
$2,000
$800
$1,200
$5,200
0.9174
$4,771
2
-
$10,000
$4,000
$6,400
-$400
-$160
-$240
$6,160
0.8417
$5,185
3
-
$10,000
$4,000
$3,840
$2,160
$864
$1,296
$5,136
0.7722
$3,966
4
-
$10,000
$4,000
$2,304
$3,696
$1,478
$2,218
$4,522
0.7084
$3,203
5
-
$10,000
$4,000
$2,304
$3,696
$1,478
$2,218
$4,522
0.6499
$2,939
6
-
$10,000
$4,000
$1,152
$4,848
$1,939
$2,909
$4,061
0.5963
$2,421
Total
$2,485
(c2) Present Worth $4,818, refer below table for detailed calculation: MARR 9%
Year
Loan Repayment
(A)
Annual Income
(B)
Operating Expenses
(C)
Interest Expenses
(D)
Depreciation
(E)
Gross Income
(F=B-C-D-E)
Tax shield @ 40%
(G=F*40%)
Net Income
(H=F-G)
Net Cash Flow
(I=A+H+E)
DCF @ 9%
(J)
NPV
(I*J)
0
-
-
-
-
-
-
-
-
-
1.0000
-
1
-
$10,000
$4,000
$2,000
$4,000
$0
$0
$0
$4,000
0.9174
$3,670
2
-
$10,000
$4,000
$2,000
$6,400
-$2,400
-$960
-$1,440
$4,960
0.8417
$4,175
3
-
$10,000
$4,000
$2,000
$3,840
$160
$64
$96
$3,936
0.7722
$3,039
4
-
$10,000
$4,000
$2,000
$2,304
$1,696
$678
$1,018
$3,322
0.7084
$2,353
5
-$20,000
$10,000
$4,000
$2,000
$2,304
$1,696
$678
$1,018
-$16,678
0.6499
-$10,840
6
-
$10,000
$4,000
-
$1,152
$4,848
$1,939
$2,909
$4,061
0.5963
$2,421
Total
$4,818
Recovery %
Depreciation
1
20%
$4,000
2
32%
$6,400
3
19.20%
$3,840
4
11.52%
$2,304
5
11.52%
$2,304
6
5.76%
$1,152
100%
$20,000
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