Question

a. Karsted Air Services is now in the final year of a project. The equipment originally cost $23 million, of which 80% has been depreciated. Karsted can sell the used equipment today for $5.75 million, and its tax rate is 30%. What is the equipment's after-tax salvage value? Round your answer to the nearest dollar. Write out your answer completely. For example, 13 million should be entered as 13,000,000.

b.Clemson Software is considering a new project whose data are shown below. The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year 1 cash flow? Do not round the intermediate calculations and round the final answer to the nearest whole number.

Equipment cost (depreciable basis)	$100,000
Straight-line depreciation rate	33.333%
Sales revenues, each year	$60,000
Operating costs (excl. depr.)	$25,000
Tax rate	35.0%

c.Project L costs $40,000, its expected cash inflows are $9,000 per year for 7 years, and its WACC is 10%. What is the project's payback? Round your answer to two decimal places.

Answer 1

a) 1.Salvage value is the value which is received from the sale of any asset after its useful life.

2.When any asset is sold above the book value then taxes would have to be paid on it.

3) Book value is the value which is entered in the books of accounts.

First we calculate value of asset after depreciation:

Original Cost= $ 23,000,000

Depreciation =80% of original cost

=$18,400,000

Value after depreciation=$46,00,000

Salvage Value=$5,750,000

Gain on sale=Salvage value-Value after depreciation

=$5,750,000-$46,00,000

=$1,150,000

Taxes on gain on sale of assets=.3*Gain on sale of asset

=.3*$1,150,000

=$345,000

Salvage Value=Salvage Value-Tax on gain on sale of asset

=$5,750,000-$345,000

=$5,405,000

b)Cash Flows:EBIT= Sales -Operating cost(Inc depreciation)

Earning after Taxes=EBT-Taxes*EBT

While calculating cash flows we add back depreciation to EBT as depreciation is not an actual outflow of cash but we definitely consider tax affect on depreciation.

Depreciation=Cost 0f asset*Rate of depreciation

=$33333

Earning before Interest and Taxes=$60000-$25000-$33333

=$1667

Taxes on EBIT=$1667*.35

=$584

EAT=EBIT-Taxes on EBIT

=$1667-$584

=$1084

Cash Flows=EAT+ Depreciation

=$1084+$33333

=$34417

c)

Year Cash Flow Present Vaue Factor@10% P.V of cash inflows Cummulative P.V of CashInflows

1 $9000 .909 $8182 $8182

2 $9000 .826 $7438 $15620

3 $9000 .751 $6762 $22382

4 $9000 .683 $6147 $28529

5 $9000 .621 $5588 $ 34117

6 $9000 .565 $5080 $39197

7 $9000 .513 $4618 $43815

Discounted Payback Period=6years+803/4618

=6.173 years

Projects payback period is 6.173years .Payback period is the time period in which any investor has recovered thre money invested.In Discounted payback period, intial investment is compared with future cash flows discounting at appropriate discount rate(WACC)