Question

2.

A

Gomi Waste Disposal is evaluating a project that would require the purchase of a piece of equipment for 185,000 dollars today. During year 1, the project is expected to have relevant revenue of 126,000 dollars, relevant costs of 33,000 dollars, and relevant depreciation of 21,000 dollars. Gomi Waste Disposal would need to borrow 185,000 dollars today to pay for the equipment and would need to make an interest payment of 5,000 dollars to the bank in 1 year. Relevant net income for the project in year 1 is expected to be 45,842 dollars. What is the tax rate expected to be in year 1? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

B

Fairfax Pizza is evaluating a project that would require an initial investment in equipment of 400,000 dollars and that is expected to last for 8 years. MACRS depreciation would be used where the depreciation rates in years 1, 2, 3, and 4 are 45 percent, 31 percent, 17 percent, and 7 percent, respectively. For each year of the project, Fairfax Pizza expects relevant, incremental annual revenue associated with the project to be 700,000 dollars and relevant, incremental annual costs associated with the project to be 608,000 dollars. The tax rate is 50 percent. What is (X plus Y) if X is the relevant operating cash flow (OCF) associated with the project expected in year 1 of the project and Y is the relevant OCF associated with the project expected in year 4 of the project?

C

Based on the following information, what is the relevant operating cash flow (OCF) associated with the project expected to be in year 3? The project would require an initial investment in equipment of 660,000 dollars that would be depreciated using MACRS where the depreciation rates in years 1, 2, 3, and 4 are 40 percent, 23 percent, 23 percent, and 14 percent, respectively. At the end of the project in 3 years, the equipment would be sold for an expected after-tax cash flow of 15,300 dollars. In year 3 of the project, relevant revenue associated with the project would be 417,400 dollars and relevant costs associated with the project would be 291,200 dollars. The tax rate is 25 percent.

D.

What is the expected after-tax cash flow from selling a piece of equipment if Red Royal Entertainment purchases the equipment today for 149,000 dollars, the tax rate is 40 percent, the equipment will be sold in 3 years for 74,000 dollars, and the equipment will be depreciated to 13,000 dollars over 17 years using straight-line depreciation?

E.

Platinum Water Health is considering a project that would last for 3 years and have a cost of capital of 12.47 percent. The relevant level of net working capital for the project is expected to be 17,000 dollars immediately (at year 0); 3,000 dollars in 1 year; 27,000 dollars in 2 years; and 0 dollars in 3 years. Relevant expected operating cash flows and cash flows from capital spending in years 0, 1, 2, and 3 are presented in the following table. What is the net present value of this project?

Answer 1

A. At year end 1 :

Revenue = $126000

Costs = $33000

Depreciation = $21000

interest = $5000

Net income = $45842

Revenue - costs - depreciation - interest - tax = net income

Hence, tax = 126000-33000-21000-5000 - 45842

= 21158

Earning beofre tax = 126000 - 33000 - 21000 -5000 = 67000

Hence tax rate = 21158/67000 = 0.31579

B. Incremental revenue and incremental costs mean that the revenue and costs increase every year by that amount. Tax rate is 50%.

Year 1 :

Revenue = 700000

Costs = 608000

Depreciation = 400000*.45 = 180000

Income before tax = 700000-608000-180000 = -88000

Income after tax = -88000(1-.5) = -44000

Opearting cash flow = net income after tax + non cash expenses = -44000+180000 = $136000 = X

Year 2 :

Revenue = 700,000 + 700,000 = 1,400,000

Costs = 608000 + 608000 = 1,216,000

Depreciation = 400000*.31 = 124000

Income before tax = 1,400,000-1,216,000-124000 = 60,000

Income after tax = 60,000(1-.5) = 30,000

Opearting cash flow = net income after tax + non cash expenses = 30,000+124000 = $154,000

Year 3 :

Revenue = 1,400,000 + 700,000 = 2,100,000

Costs = 1,216,000 + 608000 = 1,824,000

Depreciation = 400000*.17 = 68000

Income before tax = 2,100,000-1,824,000-68000 = 208,000

Income after tax = 208,000(1-.5) = 104,000

Opearting cash flow = net income after tax + non cash expenses = 104,000+68000 = $172,000

Year 4 :

Revenue = 2,100,000 + 700,000 = 2,800,000

Costs = 1,824,000 + 608000 = 2,432,000

Depreciation = 400000*.07 = 28000

Income before tax = 2,800,000-2,432,000-28000 = 340,000

Income after tax = 340,000(1-.5) = 170,000

Opearting cash flow = net income after tax + non cash expenses = 170,000+28000 = $198,000 = Y

X+Y = 136000 + 198000 = $334,000

C. Year 3 :

Revenue =$417,400

Cost = $291200

Depreciation = 660,000*23% = $151,800

Income before tax = 417400-291200-151800 = -$25600

Income after tax = -25600(1-.25) = -$19200

Operating cash flow = income after tax + non cash expenses = -19200 + 151800 = $132,600

D. Depreciation per annum = (initial cost - salvage value)/ life

=(149000-13000)/17 = $8000

Value after 3 years = 149000 - 8000-8000-8000 = $125000

Selling price = $74000

Loss on sale =125000-74000 = $51000

Tax saving on loss = 51000*40% = $20400

After tax cash flow on sale = 74,000 + 20,400 = $94,400