11 (15 points) arketing department identified a potential i . The project lasts
ID: 2780114 • Letter: 1
Question
11 (15 points) arketing department identified a potential i . The project lasts for 3 years, the initial investment in equipment is $4M. The nvestment project with the following features equipment has 5 years of life and salvage value of $0.5M. At the end of the project, you may sel l it at $2.4M he annual cost of every year. After year 3, the sales will be 0. In addition, after the introduction os how of the existing project shrinks by s 0.6M at Year 1, s0.5M at Year 2, and So.8M at ar sales revenue from the project is $8M at year 1 , S6M at year 2, and $4M at year 3. T The project 20% of sales in the following year, working capital win f land that you own. The land was originally purchased a year age MI per year. After the addition of this project, the overheads are expected Working capital required in each year is expected to be reverse back to original level when the project expires The project needs to be set up on a piece o . with SIm, and it can be rented out to other firms at SO.IM a year, ttvás proiect, payable at year end Previously, overheads were $0.2M per year. After the addition o increase to $0.35M per year. For this project, $70,000 was spent to conduct a market search corporate tax rate, 20% capital gain tax, and a 10% discount rate. Assume straight line depreciation. depreciation for this machine from year I to year 3? (2 points) Assume 40% INote: In cach question, please show your detailed work. a). What is the annual tax shield generated by Depreciation: Tax Shield: is the tax burden incurred by selling Machine X at the end of the year 3? (2 points) Tax Book Value: b). What Capital Gains Tax: c). What is the annual After-Tax Profit from the project from year 1 to year 3? What is the annual Cash F Operation from year 1 to 3? (5 points) t=1 t-2 Gross Margin Depreciation axable Income ax er-Tax Profit rating CFExplanation / Answer
Ans a. Since the depreciation is charged on SLM basis, the Depreciation per annum will be = (Cost of asset - Salvage value)/ Life of asset = (4,000,000-500,000) / 5 = $750,000 per annum.
Therefore, the annual tax shield generated by depreciation per year (1 to 3) is:
Ans b:
Sale Price = $2,400,000
Tax book value = Purchase price-depreciation charge till date = $(4000,000 - (3*700,000)) = $1,900,000
Capital Gain = $(2,400,000 -1,900,000) = $500,000
Capital Gain Tax @ 20% = 0.20*500,000 = $100,000
Ans c: Since, it is not specified when the market research expense of $70,000 was incurred, I have assumend that it was incurred at year 0. Therefore, not considered in below calculations.
Operating Cash Flows: Since, the question asks specifically for "operating" cash flows, sale/purchase of equipment and tax thereon is not considered as it is an investing activity and not operating activity.
Year 1 2 3 Depreciation 700,000 700,000 700,000 Tax shield @ 40% 280,000 280,000 280,000Related Questions
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