Aerodrome Corporation spends 5 million dollars for a sophisticated lathe to crea

Question

Aerodrome Corporation spends 5 million dollars for a sophisticated lathe to create aero-dynamically efficient missile nose cones. The system will be used for 10 years after which it will have 400,000 dollars of salvage value. The maintenance of the system will start at 20,000 per year and increase at a rate of 30,000 per year until the end of the 10 year period. The economic environment has a tax rate of 40% and an after tax MARR of 12%. Show for the ten years The Before Tax Cash Flow The depreciation allowance Taxable Income Tax After Tax Cash Flow Also show the Present Worth of System.

Explanation / Answer

In this problem, Corporation wants to buy lathe for manufacturing Missiles. Initial costs and maintenance costs are stated. Also tax rate and MARR for discounting purpose are available. You have to calculate Present worth of the system. It is total of the present value of cash flows during its entire life span of 10 years. Steps are as follows:

1. Consider initial cash outflow of 5 million. It is negative cash flow of time 0. Stated in pioint 1 of the table below:

2. Consider maintenance cost. They are also outflows and shown with negative sign

3. Consider salvage value at the end of the life i.e. 10th year. It is 400,000

4. Add figure of 1,2 and 3 to get before tax cash flow

5. Now consider depreciation. It is calculated on straight line basis. It is shown below the table. Deduct it from cash flow figures of 4 to get taxable income.

6. Calculate 40% tax and deduct it from taxable income to after tax income.

7. Now add back depreciation to get after tax cash flows.

8. Consider discount factor of each year. Use 12% MARR.

9. Ascertain present worth of yearly cash flow by multiplying cash flows after tax and discount factor

10. Finally add yearly present worth to get total present worth of the system.

Table showing calculation of present worth Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 1. Initial outflow -5000000 2. Maintenance -20000 -50000 -80000 -110000 -140000 -170000 -200000 -230000 -260000 -290000 3. Salvage value 400000 4. Cash flow     (before tax) -5000000 -20000 -50000 -80000 -110000 -140000 -170000 -200000 -230000 -260000 110000 5. Depreciation -46000 -46000 -46000 -46000 -46000 -46000 -46000 -46000 -46000 -46000 6. Taxable income (4+5) -5000000 -66000 -96000 -126000 -156000 -186000 -216000 -246000 -276000 -306000 64000 7. Tax (rate 40%) -26400 -38400 -50400 -62400 -74400 -86400 -98400 -110400 -122400 25600 8. After tax income -39600 -57600 -75600 -93600 -111600 -129600 -147600 -165600 -183600 38400 9. Add back depreciation 46000 46000 46000 46000 46000 46000 46000 46000 46000 46000 10. Cash flow after tax 6400 -11600 -29600 -47600 -65600 -83600 -101600 -119600 -137600 84400 9. Discount factor 0.89286 0.79719 0.71178 0.63552 0.56743 0.50663 0.45235 0.40388 0.36061 0.321973 10. Present worth -5000000 5714.29 -9247.4 -21069 -30251 -37223 -42354 -45959 -48304 -49620 27174.54 Total present worth -5251139 Calculation of depreciation: Assumed straight line method. So a fixed amount is charged. Depreciation is: (5000000-400000)/10= 460000

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