An investor bought a racehorse for $14 M. The horse’s average winnings were $5,3

Question

An investor bought a racehorse for $14 M. The horse’s average winnings were $5,300,000 per year and expenses averaged $500,000 per year. The horse was retired after 2 years, at which time it was sold to a breeder for $9,500,000. Assuming 3 year MACRS life for a racehorse and an income tax rate of 39%, determine the investor’s after-tax rate of return on this investment. A. The before-tax cash flow for the first two years. B. The book value at the end of the second year. Total An investor bought a racehorse for $14 M. The horse’s average winnings were $5,300,000 per year and expenses averaged $500,000 per year. The horse was retired after 2 years, at which time it was sold to a breeder for $9,500,000. Assuming 3 year MACRS life for a racehorse and an income tax rate of 39%, determine the investor’s after-tax rate of return on this investment. A. The before-tax cash flow for the first two years. B. The book value at the end of the second year. Total

Explanation / Answer

DEPRICIATION OF RACE HORSE UNDER MACRS SYSTEM

YEAR MACRS RATE CALCULATION DEPRICIATION

   1 33.33% $14000000 * 0.3333 $4666200

2 44.45% $14000000 * 0.4445 $6223000

BOOK VALUE OF THE RACE HORSE AT THE END OF 2ND YEAR

PURCHASE PRICE OF THE HORSE =$14000000

LESS- DEPRICIATION FOR 2 YEARS =($10889200)

BOOK VALUE =$3110800

BEFORE AND CASH FLOW FOR TWO YEARS

YEAR AVERAGE WINNING   AVERAGE EXPENSES   DEPRICIATION   NET CASH FLOW   

1 $5300000 ($500000) ($4666200) $133800

2   $5300000 ($500000) ($6223000) ($1423000)

AFTER TAX CASH FLOW FOR TWO YEARS

YEAR   NET CASH FLOW TAX AFTER TAX CASH FLOW

1 $133800 0.39 $81618

2 ($1423000) 0.39 ($868030)

PROFIT OR LOSS ON SELLING OF HORESE

BOOK VALUE OF THE HORSE AT THE END OF SECOND YEAR= $3110800

SELLING PRICE OF THE HORSE =$9500000

PROFIT ON SELLING =$6389200

TAX ON PROFI @39% =$2491788

AFTER TAX PROFIT =$3897412

CALCULATION OF AFTER TAX RATE OF RETURN

INVESTMENT VALUE =$14000000

PROFIT FOR 1ST YEAR =$81618

LOSS ON SECOND YEAR =($868030)

PROFIT ON SALE =$3897412

TOTAL PROFIT =$3111000

RATE OF RETURN = TOTAL PROFIT / INVESTMENT *100

=$3111000 /14000000 *100

=22.22%

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