12-24 A firm may invest in equipment that will be d A epreci- ated by double dec

Question

12-24 A firm may invest in equipment that will be d A epreci- ated by double declining balance depreciation conversion to straight-line depreciation in year 5 For depreciation purposes a $700,000 salva 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. with Before-Tax Cash Flow (in $1000) Year $12,000 1,727 2,414 2,872 3,177 3,358 1,997 1,000 Salvage value 4 If the firm wants a 9% after-tax rate of return its combined incremental income tax rate is determine by annual cash flow analysis whether investment is desirahle 34%, the

Explanation / Answer

Salvage Value 1000 As per book 700 Incremental Tax Rate 34% Required rate of retrun 9% Depreciation Per Year (as per SLM ) (12000-700)/6 1883.33 As the book value of depreciable asset is 700, whereas it was sold in 1000, profit form the sale of asset 1000-700 300 Taxable Gain 300*0.34 102 Net Proceeds 1000-102 898 Depreciation need to add back Period Pre Tax Cash Flow Post Tax Discount Factor Total Cash Flow Discounted Cash Flow 0 -12000 1139.82+1883.33 1 1727 1727*(1-34%) 1139.82 1/(1+9%)^1 0.91743 3023.15 3023.15*0.917431 2773.54 2 2414 1593.24 0.84168 3476.57 2926.16 3 2872 1895.52 0.77218 3778.85 2917.97 4 3177 2096.82 0.70843 3980.15 2819.64 5 3358 2216.28 0.64993 4099.61 2664.47 6 1997 1318.02 0.59627 3201.35 1908.86 6 1000 898 0.59627 898.00 535.45 Sum of PV of future cash flow                           16,546.08 Net Present Value 16,546.08-12000 4546.08 NPV is positive, hence Project is desirable

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