Production equipment at a cost of $500,000 has been purchased by a contract manu

Question

Production equipment at a cost of $500,000 has been purchased by a contract manufacturing company to meet the specific needs of customer that had awarded a 4-year contract with the possibility of extending the contract for another 4 years. The company plans to use the 7-year property MACRS depreciation method for this equipment. The income tax rate for the company is 39%, and it expects to have an after-tax rate of return of 12% for all its investments.
The equipment generated an annual income of $100,000 for the first four years. The customer decided not to renew the contract after 4 years. Consequently, the company decided to sell the equipment for $180,000 at the end of 4 years. Determine if the company correctly pursued this investment. yes or no??

Explanation / Answer

>>Calculation of cash inflows for 4 years.

>>Calculation of depriciation as per 7-year property MACRS depreciation method:

*As per IRS guildelines Table A-1

>>Calculation of NPV for the Project:

PVIF(12%)

{ From PVIF Table}

Cash flow $(From

above table)

Present Value $

(PVIF*CashFlow)

>> No, the company didn't pursue the project correctly as the Net present value is negative indicating a loss from the project.

Particulars Year 1 Year 2 Year 3 Year 4 Annual income (A) $100,000 $100,000 $100,000 $100,000 Less: Depriciation (As per schedule below) $ 71,450 $ 122,450 $ 87,450 $ 62,450 Net profit $ 28,550 $ -22,450 $ 12,550 $ 37,550 Profit from asset sale (S.P-WDV)(180,000-156,200) $ 23,800 Tax payable/ Tax saving @ 39% (B) $ 11,134.5 $ -8,755.5 $ 4,894.5 $ 23,926.5 Sale of asset (C) $ 180,000 Cash Inflows (A-B+C) $88,865.5 $108,755.5 $ 95,105.5 $ 265,355.5

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.