Problem 3 A medium-sized profitable corporation may buy a $25,000 F-150 for use

Question

Problem 3

A medium-sized profitable corporation may buy a $25,000 F-150 for use by the shipping and receive department. During the truck’s 5-year useful life, it is estimated the firm will save $6000 per year after all the costs of owning and operating the truck have been paid. Truck salvage value is estimated at $13,000. So that this can be solved using an equation or annuity function rather than a full spreadsheet, assume that straight-line depreciation is used.

(a) What is the before-tax rate of return?

(b) What is the after-tax rate of return on this capital expenditure? Assume straight-line depreciation.

Explanation / Answer

Tax rate is not given in the question. Thus, before-tax rate of return and after-tax rate of return will be same.

Before tax rate of return / after tax rate of return = Average annual net income after depreciation / Intial Investment

Average annual net income after depreciation = 6000 - 2400(NOTE 1) = $ 3600

Intial investment (Capital expenditure) = 25000

Before tax rate of return / after tax rate of return = 3600 / 25000 = 0.144 i.e., 14.40 %

Conclusion:- The annual Before tax rate of return / after tax rate of return on capital expenditure = 14.40 %

(NOTE 1):- Depreciation amount = 25000 - 13000 / 5 = 12000 / 5 = $ 2400

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