Problem 4. (20 Pts) A $400,000 investment in a Surface Mount Machine produces be

Question

Problem 4. (20 Pts) A $400,000 investment in a Surface Mount Machine produces before-tax net revenue of $100,000/yr for 10 years, at which time the SMP machine will have a salvage value of $15,000. We assume $250,000 is borrowed at 12% annual compound interest and repaid in 10 years. We will use a 10 year planning horizon, a 40% tax rate, at 10% BTMARR, and SLN depreciation. Determine (i) ATMARR, and then the preferred payment plan based on ATPW and determine the ATFW, ATAW, ATIRR, and ATERR for each of the following four plans:

Plan 1: Pay interest each period, but make no principal payment until the end of the loan period

Plan 2: Make equal end-of period principal payments and pay interest each period on the unpaid balance at the beginning of the period

Plan 3: Make equal end-of period payments over the loan period

Plan 4: Make no payment until the end of the loan period

Explanation / Answer

Soln : ATMARR = After Tax MARR = BTMARR*(1-effective tax rate) = 10% *(1-40%) = 6%

Here in the below table for plan 2 the top row is for remaining balance:

Based on the above calculations we can say that, plan 3 is the best option with better PW, FW among all the options and IRR would be negative in that case.

Plan1 Years 1 2 3 4 5 6 7 8 9 10 Revenue 100000 100000 100000 100000 100000 100000 100000 100000 100000 100000 Depreciation -40000 -40000 -40000 -40000 -40000 -40000 -40000 -40000 -40000 -40000 Interest -30000 -30000 -30000 -30000 -30000 -30000 -30000 -30000 -30000 -30000 Income before taxes 30000 30000 30000 30000 30000 30000 30000 30000 30000 30000 Taxes 12000 12000 12000 12000 12000 12000 12000 12000 12000 12000 Net income 18000 18000 18000 18000 18000 18000 18000 18000 18000 18000 Salvage Value 15000 Loan payment -250000 Discount rate 0.94 0.89 0.84 0.79 0.75 0.70 0.67 0.63 0.59 0.56 PV 16981.13 16019.94 15113.15 14257.69 13450.65 12689.29 11971.03 11293.42 10654.17 -121171.67 ATPW 1258.79 ATFW 2254.31 ATAW= (A/P,I,N) 3021.53 IRR 4%

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