Bert Corporation is considering an investment in equipment for $400,000. Data re

Question

Bert Corporation is considering an investment in equipment for $400,000. Data related to the investment are as follows:

Income Before

Depreciation

Year Taxes

---- ----------------

1 $150,000

2 150,000

3 150,000

4 150,000

5 150,000

The discount rate is 14 percent and the tax rate is 40 percent.

Bert uses the straight-line method of depreciation for tax purposes. The depreciable life of the equipment is five years with no salvage value. Assume that a full year of depreciation is taken in each of the five years.

Required:

a. Calculate the after-tax net income and after-tax cashflows for the first year.

b. Calculate the payback period.

c. Calculate the average rate of return (accounting rate of return on average investment).

d. Calculate the net present value.

e. Calculate the present value index.

f. Calculate the internal rate of return.

Explanation / Answer

step 1. Calculate net icome after tax

net income after tax = ( Income before dep. and tax - Depreciaton ) x (1-tax rate)

depreciation = 400000/5 = 80000 per year

net income after tax = (150000 - 80000) x (1-.40) = 42000

step 2. calculate cash flow after tax

cash flow after tax = net income after tax + depreciation

cash flow after tax = 42000 + 80000 = 122000

step 3. calculate payback period

pay back period = initial investment / net income

pay back period = 400000 / 122000 = 3.28 years

step 4. calculate average rate of return

average rate of return = net income after tax / initial investment = 42000 / 400000 = 0.105 or 10.5%

step 5. calculate net present value

net present value =(after tax cash flows x discounting factor ) - initial investment

net present value = ( 122000 x 3.433) - 400000 = 18826

step 6. present value index = 1 + (Net Present Value / Initial Investment )

present value index = 1 + 18826/400000 = 1 + 0.047 = 1.05

Thanks!

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