12-24 A firm may invest in equipment that will be depreci- A ated by double decl

Question

12-24 A firm may invest in equipment that will be depreci- A ated by double declining balance depreciation with conversion to straight-line depreciation in year 5. For depreciation purposes a $700,000 salvage value at the end of 6 years is assumed. But the actual value is thought to be $1,000,000, and it is this sum that is shown in the before-tax cash flow. Before-Tax Cash Flow (in $1000) Year 0 -$12,000 1.727 2.414 2,872 3,177 3,358 1,997 1,000 Salvage value 4 6 If the firm wants a 9% after-tax rate of return and its combined incremental income tax rate is 34%. determine by annual cash flow analysis whether the investment is desirable

Explanation / Answer

First of all lets determine the rate of depreciation

SLM rate = [(12,000,000-700,000)/6]/12000000

=1883,333/12000000

=15.69%

Rate under double declining balance method = 31.3889%

Statement showing depreciation

Statement showing NPV

Thus project should be selected

Year Opening balance Depreciation Closing balance 1 12000000 3766668 8233332 2 8233332 2584352.348 5648979.652 3 5648979.652 1773152.574 3875827.078 4 3875827.078 1216579.486 2659247.592 5 2659247.592 834708.5675 1824539.025 6 1824539.025 572702.7299 1251836.295

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