JET FAB bought a CNC laser cutting machine at a cost of $400,000 to meet the spe

Question

JET FAB bought a CNC laser cutting machine at a cost of $400,000 to meet the specific needs of customer that had given a 4-year contract with the possibility of extending the contract for another 4 years. The company uses the MACRS depreciation method for this equipment as a 7-year property for tax purposes. The income tax rate for the company is 39%, and the company expects to have an after-tax rate of return of 10% in all its investments.

The laser cutting machine generated an annual income of $80,000 for the first four years. The customer decided not to renew the contract after 4 years due to circumstances beyond its control. Consequently, the company ended up selling the CNC laser cutting machine for $150,000. Determine if the company obtained the expected after-tax rate of return on this equipment.

Explanation / Answer

under MACRS all depreciable assets are assigned to a class For CNC laser cutting machine class Asset type 7 year Machine MACRS depreciation percentage on basis of its class Depreciation as per straight line method=1/years= 1/7     =     14.29% Year (A)depreciation % (B)cost of machinery (Ax B)Depreciation 1 14.29 $                            400,000.00 $                 57,142.86 2 24.49 $                            400,000.00 $                 97,960.00 3 17.49 $                            400,000.00 $                 69,960.00 4 12.49 $                            400,000.00 $                 49,960.00 statement of income & expenses Year 1 2 3 4 Particulars Annual income $               80,000.00 $                              80,000.00 $                 80,000.00 $        80,000.00 Depreciation $               57,142.86 $                              97,960.00 $                 69,960.00 $        49,960.00 EBT $               22,857.14 $                            (17,960.00) $                 10,040.00 $        30,040.00 tax 39% $                 8,914.29 $                                              -   $                   3,915.60 $        11,715.60 EAT $               13,942.86 $                            (17,960.00) $                   6,124.40 $        18,324.40 calculating whether company obtained the expected after tax rate of return on equipment/machinery Year Particulars (A)cashflow/(outflow) (B)PV factor 10% (A x B)Amount 0 Machinery purchased $                          (400,000.00) 1 $   (400,000.00) 1 EAT $                              13,942.86 0.909090909 $        12,675.32 2 EAT $                            (17,960.00) 0.826446281 $      (14,842.98) 3 EAT $                                 6,124.40 0.751314801 $          4,601.35 4 EAT $                              18,324.40 0.683013455 $        12,515.81 4 Sale of machine $                            120,000.00 0.683013455 $        81,961.61 NET NPV $   (303,088.87) here net NPV is negative i.e, less than zero Hence , we can say that company has not obtained the expected after tax return on equipment/machinery

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