A telephone distribution company is considering building a new automated switchi

Question

A telephone distribution company is considering building a new automated switching equipment substation with a useful life of 20 years. The company uses a 14% MARR to assess capital investment projects. Estimated real dollar costs and benefits are as follows: Category Amount Building initial cost $1,000,000 Equipment initial cost $ 500,000 Equipment salvage value $ 25,000 Annual gross income $ 300,000 year 1 Income gradient years 2 - 5 $ 25,000 Annual gross income $ 400,000 years 6 - 20 Annual operating expenses $ 160,000 first 10 years $ 200,000 years 11 to 15 $ 250,000 years 16 to 20 The substation will be put into service on the first day of the company

Explanation / Answer

a. If the firm reduces its reported income by the amount of the depreciation expense calculated below, what tax savings will result?
For a 5-year asset, the depreciation rate is 20% for the first year.
80,000 x 20% = $16,000 depreciation expense
This will reduce pre-tax income to $414,000. Without knowing the percentage income tax, it's impossible to know the tax savings.
b. Assuming that telephone company does purchase the equipment this year and that they are its only depreciable asset, find the firm’s cash flow from operations for the year.
Cash flow from operations would be increased by the amount of depreciation (16,000)

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