Biotechnics Engineering has developed two mutually exclusive plans for investing
ID: 1190135 • Letter: B
Question
Biotechnics Engineering has developed two mutually exclusive plans for investing in new
capital equipment with the expectation of increased revenue from its medical diagnostic ser-
vices to cancer patients. The estimates are summarized below. (a) Use classical straight line
depreciation, an after-tax MARR of 12%, and an effective tax rate of 40% to perform two an-
nual worth after-tax analyses: CFBT and CFAT. (b) Explain the fundamental difference between
the results of the two analyses.
Plan A Plan B
Initial investment, $ 500,000 1,200,000
Gross income expenses, $ 170,000 per year 600,000 in year 1, decreasing by 100,000
per year thereafter
Estimated life, years 4 4
Salvage value None None
Explanation / Answer
Plan A CF0 -500000 Depriciation 500000/4 125000 Before Tax Cash Inflow ( depriciation is a non cash item) Calculation of discounting factor PV of cash inflows Gross Income =Gross Income CF1 170000 170000 1.12 1.12 1/1.12 0.8929 170000*0.892857142857143 151785.7143 CF2 170000 170000 1.12^2 1.2544 1/1.2544 0.7972 170000*0.79719387755102 135522.9592 CF3 170000 170000 1.12^3 1.404928 1/1.404928 0.7118 170000*0.711780247813411 121002.6421 CF4 170000 170000 1.12^4 1.5735194 1/1.57351936 0.6355 170000*0.635518078404831 108038.0733 PV of cash inflows 516349.3889 Cash Outflow 500000 Net cash (Inflow- outflow) = 16349.38893 After Tax Cash Inflow ( depriciation is a non cash item) Calculation of discounting factor PV of cash inflows Gross Income Depriciation Taxes paid =Gross Income - taxes paid CF1 170000 125000 (170000-125000)*.40 18000 152000 1.12 1.12 1/1.12 0.8929 152000*0.892857142857143 135714.3 CF2 170000 125000 (170000-125000)*.40 18000 152000 1.12^2 1.2544 1/1.2544 0.7972 152000*0.79719387755102 121173.5 CF3 170000 125000 (170000-125000)*.40 18000 152000 1.12^3 1.404928 1/1.404928 0.7118 152000*0.711780247813411 108190.6 CF4 170000 125000 (170000-125000)*.40 18000 152000 1.12^4 1.57351936 1/1.57351936 0.6355 152000*0.635518078404831 96598.75 PV of cash inflows 461677.1 Cash Outflow 500000 Net Cash (Inflow-Outflow) -38322.9 Plan B CF0 -1200000 Depriciation 1200000/4 300000 Before Tax Cash Inflow ( depriciation is a non cash item) Calculation of discounting factor PV of cash inflows Gross Income =Gross Income CF1 600000 600000 1.12 1.12 1/1.12 0.8929 600000*0.892857142857143 535714.2857 CF2 500000 500000 1.12^2 1.2544 1/1.2544 0.7972 500000*0.79719387755102 398596.9388 CF3 400000 400000 1.12^3 1.404928 1/1.404928 0.7118 400000*0.711780247813411 284712.0991 CF4 300000 300000 1.12^4 1.5735194 1/1.57351936 0.6355 300000*0.635518078404831 190655.4235 PV of cash inflows 1409678.747 Cash Outflow 1200000 Net cash (Inflow- outflow) = 209678.7471 After Tax Cash Inflow ( depriciation is a non cash item) Calculation of discounting factor PV of cash inflows Gross Income Depriciation Taxes paid =Gross Income - taxes paid CF1 600000 300000 (600000-300000)*.40 120000 480000 1.12 1.12 1/1.12 0.8929 480000*0.892857142857143 428571.4 CF2 500000 300000 (500000-300000)*.40 80000 420000 1.12^2 1.2544 1/1.2544 0.7972 420000*0.79719387755102 334821.4 CF3 400000 300000 (400000-300000)*.40 40000 360000 1.12^3 1.404928 1/1.404928 0.7118 360000*0.711780247813411 256240.9 CF4 300000 300000 (300000-300000)*.40 0 300000 1.12^4 1.57351936 1/1.57351936 0.6355 300000*0.635518078404831 190655.4 PV of cash inflows 1210289 Cash Outflow 1200000 b) From both the analysis i.e. before tax and after tax project B should be selected. Net Cash (Inflow-Outflow) 10289.17 Before tax both projects A& B, has positive cash flows but after considering taxes project B should be selected as project A has negative cash flows.
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