The R&D of the Advanced Electronics, Inc. (AE) designed a product commissioned b
ID: 2646506 • Letter: T
Question
The R&D of the Advanced Electronics, Inc. (AE) designed a product commissioned by the military, but with applications in commercial markets as well. To manufacture and market the product AE needs to build new manufacturing facilities, and will need an initial investment of $8 million. The company expects to sell 5,000 units annually for the next five years at a price of $2,800 per unit. The expected salvage value of the manufacturing facilities at the end of five years is expected to be $1.9 million, and the facility will be depreciated according to a seven-year MACRS property class. The operating and maintenance costs are estimated to be $1.1 million per year. The manufacturing cost will be $1,200 per unit, and it does not include depreciation. The combined (federal and state) tax rate for AE is 34%, and this project will not change the company
Explanation / Answer
We will have to use the MACRS depreciation rates for calculating the amount of depreciation. Additional taxable income is the difference between the sales value and the estimated costs (including depreciation for each year.
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Step 1: Calculate Depreciation for Each Year
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Step 2: Calculate Additional Taxable Income, Income Taxes and Net Income Generated for AE
Net Income for Final Year (Year 5) may also require the adjustment for after tax salvage value. The after-tax salvage value is the difference between the sales value and the book value. It also includes/excludes tax on loss/gain arising from disposal.
Book Value = 8,000,000 - 1,143,200 - 1,959,200 - 1,399,200 - 999,200 - 714,400 = 1,784,800
Gain on Disposal = Salvage Value - Book Value = 1,900,000 - 1,784,800 = $115,200
After Tax Salvage Value = Salvage Value - Tax on Gain = 1,900,000 - 34%*115,200 = $1,860,832
The net income generated for final year will change (increase to $5,943,328) by $1,860,832 if we take the after tax salvage value into consideration.
Year Value (A) Depreciation Rate (B) Depreciation (A*B) Year 1 8,000,000 14.29% 1,143,200 Year 2 8,000,000 24.49% 1,959,200 Year 3 8,000,000 17.49% 1,399,200 Year 4 8,000,000 12.49% 999,200 Year 5 8,000,000 8.93% 714,400Related Questions
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