Question

1. The taxi company you work for is considering buying a $50,000 car which they expect to last two years. Operating & Maintenance O&M costs are $12,000 per year. The car is expected to generate $32,000 in revenues per year. The tax rate is 30%. The company’s minimum acceptable rate of return (MARR) is 20%.

The taxi company uses a declining balance method for depreciation. The book balance of the car value at the end of year 0 is the price of the car. The book balance at the end of year n, Bn = Bn-1 – depreciation that year. The depreciation in a year is 40% of the book balance at the beginning of year, where the book balance at the beginning of year n is the book balance at the end of year n – 1. The salvage value is assumed to the book balance at the end of the investment.

a. Calculate the depreciation for each year.

b. Calculate the salvage value of the car.

c. Create the Income Statement for this investment.

d. Create the Statement of Cash Flows for this investment.

e. Use the NPV method to determine if the company should buy the car.

Answer 1

A) Depreciation in year 1

= book value × depreciation rate

=50,000 × 40%

= $20,000

Book value after depreciation = 50,000 - 20,000 = 30,000

Depreciation in year 2

= 30,000 × 40%

= $12,000

B) Salvage value of Car = Book value at the end of year 1 - depreciation of year 2

= 30,000 - 12,000

= $18,000

salvage value after tax = 18,000 × (1-0.30)

= 18,000 × 0.70

= $12,600

C) Income statement for year 1

Revenue = 32,000

(-) cost = (12,000)

EBITDA= 20,000

(-)depreciation, = (20,000)

EBT= 0

(-) tax = 0

Net profit= 0

Income statement for year 2

Revenue = 32,000

(-) cost = (12,000)

EBITDA= 20,000

(-) depreciation= (12,000)

EBT= 8,000

(-) Tax 30% = (2,400)

Net profit = $5,600

D) Statement of cash flow year 1

Operating cash flow of year 1 = Net profit + depreciation

= 0 + 20,000

= $20,000

Operating cash flow of year 2 = Net profit + depreciation

= 5,600 + 12,000

= $17,600

e) Using financial calculator to calculate Npv

Inputs:- C0= -50,000

C1= 20,000. Frequency=1

   C2= (operating cash flow in year 2 + after tax salvage value) 17,600 + 12,600 = 30,200 Frequency= 1

I= 20%

Npv= compute

We get, Npv as -$12,361.11

As the Npv is negative , we should not buy the car.