beta corp wants to invest $10M in new equipment to enhance its manufacturing pro

Question

beta corp wants to invest $10M in new equipment to enhance its manufacturing process. This will result in additional (taxable) cash inflows of $1.1M annually for the next 15 years.The equipment will be depreciated over 10 years (no savage value. Assume a current corporate tax rate of 34% and a discount rate of 5%. Evaluate this investment for each of the following four situations: a. Marginal tax rate will decrease to 25% at the end of year 5. b. the marginal tax rate will increase to 40% at end of year 10. c. the equipment will not last for 15 years but only for 12 years. d. the benefit from the investment is $1.2M per year instead of $1.1M per year.

Explanation / Answer

ans a 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Cash flows ($10) $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 Less: Depreciation (10/10) 1 1 1 1 1 1 1 1 1 1 Net increase in income N $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $1.10 $1.10 $1.10 $1.10 $1.10 Tax rate T 34% 34% 34% 34% 25% 25% 25% 25% 25% 25% 25% 25% 25% 25% 25% Income after tax N*(1-T%) 0.066 0.066 0.066 0.066 0.075 0.075 0.075 0.075 0.075 0.075 0.825 0.825 0.825 0.825 0.825 Add: depreciation 1 1 1 1 1 1 1 1 1 1 Total cash flows ($10) 1.066 1.066 1.066 1.066 1.075 1.075 1.075 1.075 1.075 1.075 0.825 0.825 0.825 0.825 0.825 Discount factor 5% 1 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 Discounted cash flow ($10) $1.015 $0.967 $0.921 $0.877 $0.842 $0.802 $0.764 $0.728 $0.693 $0.660 $0.482 $0.459 $0.438 $0.417 $0.397 NPV (total of all) $0.462 ans b 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Cash flows ($10) $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 Less: Depreciation (10/10) 1 1 1 1 1 1 1 1 1 1 Net increase in income N $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $1.10 $1.10 $1.10 $1.10 $1.10 Tax rate T 34% 34% 34% 34% 34% 34% 34% 34% 34% 40% 40% 40% 40% 40% 40% Income after tax N*(1-T%) 0.066 0.066 0.066 0.066 0.066 0.066 0.066 0.066 0.066 0.06 0.66 0.66 0.66 0.66 0.66 Add: depreciation 1 1 1 1 1 1 1 1 1 1 Total cash flows ($10) 1.066 1.066 1.066 1.066 1.066 1.066 1.066 1.066 1.066 1.06 0.66 0.66 0.66 0.66 0.66 Discount factor 5% 1 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 Discounted cash flow ($10) $1.015 $0.967 $0.921 $0.877 $0.835 $0.795 $0.758 $0.722 $0.687 $0.651 $0.386 $0.368 $0.350 $0.333 $0.317 NPV (total of all) ($0.018) ans c 0 1 2 3 4 5 6 7 8 9 10 11 12 Cash flows ($10) $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 $1.10 Less: Depreciation (10/10) 1 1 1 1 1 1 1 1 1 1 Net increase in income N $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $0.10 $1.10 $1.10 Tax rate T 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% Income after tax N*(1-T%) 0.066 0.066 0.066 0.066 0.066 0.066 0.066 0.066 0.066 0.066 0.726 0.726 Add: depreciation 1 1 1 1 1 1 1 1 1 1 Total cash flows ($10) 1.066 1.066 1.066 1.066 1.066 1.066 1.066 1.066 1.066 1.066 0.726 0.726 Discount factor 5% 1 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 Discounted cash flow ($10) $1.015 $0.967 $0.921 $0.877 $0.835 $0.795 $0.758 $0.722 $0.687 $0.654 $0.424 $0.404 $0.000 $0.000 $0.000 NPV (total of all) ($0.940) ans d 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Cash flows ($10) $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 $1.20 Less: Depreciation (10/10) 1 1 1 1 1 1 1 1 1 1 Net increase in income N $0.20 $0.20 $0.20 $0.20 $0.20 $0.20 $0.20 $0.20 $0.20 $0.20 $1.20 $1.20 $1.20 $1.20 $1.20 Tax rate T 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% 34% Income after tax N*(1-T%) 0.132 0.132 0.132 0.132 0.132 0.132 0.132 0.132 0.132 0.132 0.792 0.792 0.792 0.792 0.792 Add: depreciation 1 1 1 1 1 1 1 1 1 1 Total cash flows ($10) 1.132 1.132 1.132 1.132 1.132 1.132 1.132 1.132 1.132 1.132 0.792 0.792 0.792 0.792 0.792 Discount factor 5% 1 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 Discounted cash flow ($10) $1.078 $1.027 $0.978 $0.931 $0.887 $0.845 $0.804 $0.766 $0.730 $0.695 $0.463 $0.441 $0.420 $0.400 $0.381 NPV (total of all) $0.846 The best situation is Option D as it produces highest NPV

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