A project for a new telephone distribution plant did not yield estimated sales a
ID: 2462922 • Letter: A
Question
A project for a new telephone distribution plant did not yield estimated sales and is being terminated with no ($0) market value, because the telephone equipment will be converted to produce another product. The project had the following cash flows in actual dollars. The company uses a real interest rate i’ = 10% for this product, and inflation is expected to maintain at a 5% average. The telephone distribution company uses MACRS depreciation and has a combined tax rate is 45%. Estimate the after tax cash actual dollar cash flows, convert the actual dollar cash flows to real dollars, and compute the net present worth in real dollars. Cash flows are in actual dollars.
Actual $ O&M Taxable After Tax
Year Init Cost Revenues Costs Depr. Income Taxes Cash Flow Real$
0 ($20,000)
1 $20,000 $10,000
2 $20,000 $10,000
3 $20,000 $10,000
Book Value ______
Depreciation Recapture/Loss ______
Explanation / Answer
Working notes:
(1) MACRS Depreciation schedule (Assuming 3 years life & Half-year convention)
(2) Taxable income (TI) = Revenue - O&M Cost - Depreciation
(3) After tax cash flow (ATCF) = Taxable income - Tax (@45%) + Depreciation (Since depreciation is non-cash expense, it is added back to after-tax income to derive After-tax Cash Flow) - Initial cost
(3) Real dollar ATCF = ATCF as computed / (1 + Inflation rate) = ATCF as computed / 1.05**
**Real ATCF, year 0 = Actual initial cost
(4) Net present worth (NPW) is sum of all real dollar ATCF discounted at 10%.
Year Depreciation Base ($) Depreciation % Annual Depreciation ($) (A) (B) (A) x (B) 1 20,000 33.33 6,666 2 20,000 44.45 8,890 3 20,000 14.81 2,962Related Questions
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