Problem 4. (20 Pts) A $400,000 investment in a Surface Mount Machine produces before-tax net revenue...

Problem 4. (20 Pts) A $400,000 investment in a Surface Mount Machine produces before-tax net revenue of $100,000/yr for 10 years, at which time the SMP machine will have a salvage value of $15,000. We assume $250,000 is borrowed at 12% annual compound interest and repaid in 10 years. We will use a 10 year planning horizon, a 40% tax rate, at 10% BTMARR, and SLN depreciation. Determine (i) ATMARR, and then the preferred payment plan based on ATPW and determine the ATFW, ATAW, ATIRR, and ATERR for each of the following four plans:

Plan 1: Pay interest each period, but make no principal payment until the end of the loan period

Plan 2: Make equal end-of period principal payments and pay interest each period on the unpaid balance at the beginning of the period

Plan 3: Make equal end-of period payments over the loan period

Plan 4: Make no payment until the end of the loan period

Expert Solution

Soln : ATMARR = After Tax MARR = BTMARR*(1-effective tax rate) = 10% *(1-40%) = 6%

Plan1
Years	1	2	3	4	5	6	7	8	9	10
Revenue	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Depreciation	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000
Interest	-30000	-30000	-30000	-30000	-30000	-30000	-30000	-30000	-30000	-30000
Income before taxes	30000	30000	30000	30000	30000	30000	30000	30000	30000	30000
Taxes	12000	12000	12000	12000	12000	12000	12000	12000	12000	12000
Net income	18000	18000	18000	18000	18000	18000	18000	18000	18000	18000
Salvage Value										15000
Loan payment										-250000
Discount rate	0.94	0.89	0.84	0.79	0.75	0.70	0.67	0.63	0.59	0.56
PV	16981.13	16019.94	15113.15	14257.69	13450.65	12689.29	11971.03	11293.42	10654.17	-121171.67
ATPW	1258.79
ATFW	2254.31
ATAW= (A/P,I,N)	3021.53
IRR	4%

Here in the below table for plan 2 the top row is for remaining balance:

Plan2		225000	200000	175000	150000	125000	100000	75000	50000	25000
Years	1	2	3	4	5	6	7	8	9	10
Revenue	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Depreciation	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000
Interest	-30000	-27000	-24000	-21000	-18000	-15000	-12000	-9000	-6000	-3000
Income before taxes	30000	33000	36000	39000	42000	45000	48000	51000	54000	57000
Taxes	12000	13200	14400	15600	16800	18000	19200	20400	21600	22800
Net income	18000	19800	21600	23400	25200	27000	28800	30600	32400	34200
Salvage Value										15000
Loan payment	-25000	-25000	-25000	-25000	-25000	-25000	-25000	-25000	-25000	-25000
Discount rate	0.94	0.89	0.84	0.79	0.75	0.70	0.67	0.63	0.59	0.56
PV	-6603.77	-4627.98	-2854.71	-1267.35	149.45	1409.92	2527.22	3513.51	4380.05	13513.15
ATPW	10139.49
ATFW	18158.28
ATAW= (A/P,I,N)	3021.53
IRR	-1%

Plan3
Years	1	2	3	4	5	6	7	8	9	10
Revenue	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Depreciation	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000
Interest	-44246.04	-44246.04	-44246.04	-44246.04	-44246.04	-44246.04	-44246.04	-44246.04	-44246.04	-44246.04
Income before taxes	15753.96	15753.96	15753.96	15753.96	15753.96	15753.96	15753.96	15753.96	15753.96	15753.96
Taxes	6301.58	6301.58	6301.58	6301.58	6301.58	6301.58	6301.58	6301.58	6301.58	6301.58
Net income	9452.38	9452.38	9452.38	9452.38	9452.38	9452.38	9452.38	9452.38	9452.38	9452.38
Salvage Value										15000
Loan payment
Discount rate	0.94	0.89	0.84	0.79	0.75	0.70	0.67	0.63	0.59	0.56
PV	8917.34	8412.58	7936.40	7487.17	7063.36	6663.55	6286.37	5930.54	5594.85	13654.08
ATPW	77946.23
ATFW	139589.82
ATAW= (A/P,I,N)	3021.53

Plan4
Years	1	2	3	4	5	6	7	8	9	10
Revenue	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Depreciation	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000
Interest	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00
Income before taxes	60000.00	60000.00	60000.00	60000.00	60000.00	60000.00	60000.00	60000.00	60000.00	60000.00
Taxes	24000.00	24000.00	24000.00	24000.00	24000.00	24000.00	24000.00	24000.00	24000.00	24000.00
Net income	36000.00	36000.00	36000.00	36000.00	36000.00	36000.00	36000.00	36000.00	36000.00	36000.00
Salvage Value										15000
Loan payment										-776462.0521
Discount rate	0.94	0.89	0.84	0.79	0.75	0.70	0.67	0.63	0.59	0.56
PV	33962.26	32039.87	30226.29	28515.37	26901.29	25378.58	23942.06	22586.85	21308.34	-405094.22
ATPW	-160233.30
ATFW	-286953.43
ATAW= (A/P,I,N)	3021.53
IRR	11%

Based on the above calculations we can say that, plan 3 is the best option with better PW, FW among all the options and IRR would be negative in that case.

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