Problem 2 A firm is considering renewing its equipment to meet increaseddemand f

Question

Problem 2

A firm is considering renewing its equipment to meet increaseddemand for its product. The cost of equipment modifications is $1.9million plus $100,000 in installation costs. The firm willdepreciate the equipment modifications under MACRS, using a 5-yearrecovery period. Additional sales revenue from the renewal shouldamount to $1.2 million per year, and additional operating expensesand other costs (excluding depreciation and interest) will amountto 40% of the additional sales. The firm is subject to a tax rateof 40%. For each of the next 6 years.

a. Determine earnings before depreciation, interest, and taxesthat will result from the renewal?  

b. Determine net operating profits after taxes that willresult   from the renewal?

Explanation / Answer

Equipment ModificationsCost   = $1,900,000 +$100,000 = $2,000,000 (a) Calculating EBIT &D: Sales Revenue $1,200,000.00 Less: Operating Expenses & Costs ($1,200,000 * 40%) $480,000.00 Earnings Before Depreciation, Interestand Taxes (EBIT & D) $720,000.00 (b) Calculating Net OperatingProfits After Taxes : Sales Revenue $1,200,000.00 Less: Operating Expenses & Costs $480,000.00 Operating Profit Before Tax and Depreciation $720,000.00 Less: Depreciation (using 5year MACRS Dep) $116,000.00 ($2,000,000 * 0.058) Earnings Before Taxes (EBT) $604,000.00 Less: Tax (40%) $241,600.00 Net Earnings After Taxes (or) $362,400.00 Net Operating Profit AfterTax Hope it may help you Equipment ModificationsCost   = $1,900,000 +$100,000 = $2,000,000 (a) Calculating EBIT &D: Sales Revenue $1,200,000.00 Less: Operating Expenses & Costs ($1,200,000 * 40%) $480,000.00 Earnings Before Depreciation, Interestand Taxes (EBIT & D) $720,000.00 (b) Calculating Net OperatingProfits After Taxes : Sales Revenue $1,200,000.00 Less: Operating Expenses & Costs $480,000.00 Operating Profit Before Tax and Depreciation $720,000.00 Less: Depreciation (using 5year MACRS Dep) $116,000.00 ($2,000,000 * 0.058) Earnings Before Taxes (EBT) $604,000.00 Less: Tax (40%) $241,600.00 Net Earnings After Taxes (or) $362,400.00 Net Operating Profit AfterTax

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