The Summitt Petroleum Corporation will purchase an asset that qualifies for thre
ID: 2627232 • Letter: T
Question
The Summitt Petroleum Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $220,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years: Use Table 12-12 http://lectures.mhhe.com/connect/0077861612/ch12/Table_12_12.jpg.
Year 1 $104,000
Year 2 $128,000
Year 3 $52,000
Year 4 $50,000
The firm is in a 35 percent tax bracket and has a cost of capital of 12 percent. Use Appendix B http://lectures.mhhe.com/connect/0077861612/Appendix_B.jpg for an approximate answer but calculate your final answer using the formula and financial calculator methods.
a. Calculate the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.) Net present value $
b. Under the net present value method, should Summitt Petroleum Corporation purchase the asset? Yes No
Explanation / Answer
PART A : - Schedule for Calculation of Net Present Value
Year
0
1
2
3
4
Earnings before depreciation and taxes
$ -
$ 104,000.00
$ 128,000.00
$ 52,000.00
$ 50,000.00
Less: Depreciation (33.30%; 44.50%; 14.80% and 7.40%)
$ -
$ (73,260.00)
$ (97,900.00)
$ (32,560.00)
$ (16,280.00)
Earnings before taxes
$ -
$ 30,740.00
$ 30,100.00
$ 19,440.00
$ 33,720.00
Less: Tax @ 35%
$ -
$ (10,759.00)
$ (10,535.00)
$ (6,804.00)
$ (11,802.00)
Net Income
$ -
$ 19,981.00
$ 19,565.00
$ 12,636.00
$ 21,918.00
Add: Depreciation (Being non-cash in nature)
$ -
$ 73,260.00
$ 97,900.00
$ 32,560.00
$ 16,280.00
Annual Cash Flows
$ -
$ 93,241.00
$ 117,465.00
$ 45,196.00
$ 38,198.00
Cost of Purchase
$ (220,000.00)
$ -
$ -
$ -
$ -
Project Cash Flows
$ (220,000.00)
$ 93,241.00
$ 117,465.00
$ 45,196.00
$ 38,198.00
Present Value factor of 12% (1/1.12N)
1.00000000
0.89285714
0.79719388
0.71178025
0.63551808
Present Value of Cash Flows
$ (220,000.00)
$ 83,250.89
$ 93,642.38
$ 32,169.62
$ 24,275.52
Net Present Value
$ 13,338.41 (Answer)
PART B: - YES, Summitt Petroleum Corporation should purchase the asset because it has a positive NPV of $13,338.41 (Answer)
PART A : - Schedule for Calculation of Net Present Value
Year
0
1
2
3
4
Earnings before depreciation and taxes
$ -
$ 104,000.00
$ 128,000.00
$ 52,000.00
$ 50,000.00
Less: Depreciation (33.30%; 44.50%; 14.80% and 7.40%)
$ -
$ (73,260.00)
$ (97,900.00)
$ (32,560.00)
$ (16,280.00)
Earnings before taxes
$ -
$ 30,740.00
$ 30,100.00
$ 19,440.00
$ 33,720.00
Less: Tax @ 35%
$ -
$ (10,759.00)
$ (10,535.00)
$ (6,804.00)
$ (11,802.00)
Net Income
$ -
$ 19,981.00
$ 19,565.00
$ 12,636.00
$ 21,918.00
Add: Depreciation (Being non-cash in nature)
$ -
$ 73,260.00
$ 97,900.00
$ 32,560.00
$ 16,280.00
Annual Cash Flows
$ -
$ 93,241.00
$ 117,465.00
$ 45,196.00
$ 38,198.00
Cost of Purchase
$ (220,000.00)
$ -
$ -
$ -
$ -
Project Cash Flows
$ (220,000.00)
$ 93,241.00
$ 117,465.00
$ 45,196.00
$ 38,198.00
Present Value factor of 12% (1/1.12N)
1.00000000
0.89285714
0.79719388
0.71178025
0.63551808
Present Value of Cash Flows
$ (220,000.00)
$ 83,250.89
$ 93,642.38
$ 32,169.62
$ 24,275.52
Net Present Value
$ 13,338.41 (Answer)
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