Zoom Car Corporation (ZCC) plans to purchase approximately 100 vehicles on Decem
ID: 2481716 • Letter: Z
Question
Zoom Car Corporation (ZCC) plans to purchase approximately 100 vehicles on December 31, 2015, for $2.5 million, plus 11 percent total sales tax. ZCC expects to use the vehicles for 5 years and then sell them for approximately $525,000. ZCC anticipates the following average vehicle use over each year ended December 31 2016 15,000 2017 20,000 2018 11,250 2020 5,000 Miles per year 11,250 To finance the purchase, ZCC signed a 5-year promissory note on December 31, 2015, for $2.25 million, with interest paid annually at the market interest rate of 5 percent. The note carries loan covenants that require ZCC to maintain a minimum times interest earned ratio of 3.0 and a minimum fixed asset turnover ratio of 1.0. ZCC forecasts that the company wil generate the following sales and preliminary earnings (prior to recording depreciation on the vehicles and interest on the note). (For purposes of this question, ignore income tax.) (in 000s) Sales Revenue 2017 2018 2019 2020 2,500 3,000 3,300 3,400 3,500 1,450 1,650 1,750 1,850 2016 Income before Depreciation and Interest Expense 1,250Explanation / Answer
Cost of 100 vehicles 2500000 Sales tax on purchase 275000 ( 11% on purchase price) Total Cost of Vehicles 2775000 Residual Value 525000 Life of assets 5 years Depreciation using straight line method can be calculated as This method of recording depreciation is simpler then other methods as it spreads cost of asset equally in number of years of use of asset = ( cost of asset - residual value) / life of asset = (2775000-525000) / 5 years = 450000 per year Deprecitation chart under straight line balance method year Cost / Book Value Depreciation Accumulated Book Value at beginning Expense Depreciation Year end 2016 2775000 450000 450000 2325000 2017 2325000 450000 900000 1875000 2018 1875000 450000 1350000 1425000 2019 1425000 450000 1800000 975000 2020 975000 450000 2250000 525000 b) Double declining balance method This is little more complicated then basic straight line method and is used in cases where usage of asset is more in initial years and lesser in following years. Calculated as 2 x straight line depreciation rate = 2 x 20% , =40 % For this purpose Straight line depreciation rate here is calculated as = Depreciation amount / cost of asset = 555000 / 2775000 = 20 % Now, Depreciation for this purpose was calculated as = Cost of asset / life of asset = 2775000 / 5 years =555000 per year Deprecitation chart under Double declining balance method year Cost / Book Value Depreciation Depreciation Accumulated Book Value at beginning Rate Expense Depreciation Year end 2016 2775000 40% 1110000 1110000 1665000 2017 1665000 40% 666000 1776000 999000 2018 999000 40% 399600 2175600 599400 2019 599400 12.41% 74400 2250000 525000 2020 525000 0% 0 2250000 525000 As under Double declining method book value can not fall below Residual value , therfore depreciation in year 2019 and 2020 has been adjusted c) Year Miles Per year Depreciation 2016 15000 540000 2017 20000 720000 2018 11250 405000 2019 11250 405000 2020 5000 180000 Total 62500 2250000 Depreciation under unit of production method can be calculated as = ( cost of asset - residual value) / Total Miles = (2775000-525000) / 62500 = $ 36 per miles Using this depreciation rate we can calculate depreciation per year on basis of miles travelled Deprecitation chart under unit of production method year Cost / Book Value Depreciation Accumulated Book Value at beginning Expense Depreciation Year end 2016 2775000 540000 540000 2235000 2017 2235000 720000 1260000 1515000 2018 1515000 405000 1665000 1110000 2019 1110000 405000 2070000 705000 2020 705000 180000 2250000 525000 Now we calculate interest on loan as = amount outstanding x interest rate = 2250000 x 5% = 112500 per year a) Workings under straight line method Amounts in 1000's 2016 2017 2018 2019 2020 Sale Value 2500 3000 3300 3400 3500 Income before depreciation and interest 1250 1450 1650 1750 1850 Less: Depreciation 450 450 450 450 450 Income before interest and Taxes (EBIT) 800 1000 1200 1300 1400 Less Interest 112.5 112.5 112.5 112.5 112.5 Net Income 687.5 887.5 1087.5 1187.5 1287.5 Times Interest ratio it measures how many times earnings cover interest expense = EBIT / interest expense 7.11 8.89 10.67 11.56 12.44 Book value Asset 2325 1875 1425 975 525 Asset turnover rartio - it specifies how well aassets are used to generate revenue = Net Annual Sales / Net Book value at end of year 1.08 1.60 2.32 3.49 6.67 b) Workings under double declining method Amounts in 1000's 2016 2017 2018 2019 2020 Sale Value 2500 3000 3300 3400 3500 Income before depreciation and interest 1250 1450 1650 1750 1850 Less: Depreciation 1110 666 399.6 74.4 0 Income before interest and Taxes (EBIT) 140 784 1250.4 1675.6 1850 Less Interest 112.5 112.5 112.5 112.5 112.5 Net Income 27.5 671.5 1137.9 1563.1 1737.5 Times Interest ratio it measures how many times earnings cover interest expense = EBIT / interest expense 1.24 6.97 11.11 14.89 16.44 Book value Asset 1665 999 599.4 525 525 Asset turnover rartio - it specifies how well aassets are used to generate revenue = Net Annual Sales / Net Book value at end of year 1.50 3.00 5.51 6.48 6.67 c) Workings under unit of production method Amounts in 1000's 2016 2017 2018 2019 2020 Sale Value 2500 3000 3300 3400 3500 Income before depreciation and interest 1250 1450 1650 1750 1850 Less: Depreciation 5.4 7.2 4.05 4.05 1.8 Income before interest and Taxes (EBIT) 1244.6 1442.8 1645.95 1745.95 1848.2 Less Interest 112.5 112.5 112.5 112.5 112.5 Net Income 1132.1 1330.3 1533.45 1633.45 1735.7 Times Interest ratio it measures how many times earnings cover interest expense = EBIT / interest expense 11.06 12.82 14.63 15.52 16.43 Book value Asset 2235 1515 1110 705 525 Asset turnover rartio - it specifies how well aassets are used to generate revenue = Net Annual Sales / Net Book value at end of year 1.12 1.98 2.97 4.82 6.67 4 Straight line Not Violated Double declining Violated unit of production Not Violated
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