Question

1. To maintain a strong credit rating, Freedom will borrow $1.2 million today to finance the Ingleburn facility’s expansion. The ten-year principal-and-interest loan has annual interest repayments of $147,949 (assuming a 4% p.a. rate). Freedom’s accountant confirms that interest is classified as a business expense and is tax deductible.

2. There is an anticipated expense of $180,000 to install the equipment associated with the Ingleburn expansion, and a $50,000 cost to upgrade the electricity supply required to commence operations. According to the ATO both of these items are classified as a business expense. The manager of the Ingleburn facility would prefer to classify these expenses as assets and therefore depreciate them over the ten-year project life to give the appearance of higher profitability for the 2018 financial year. The manager is budgeting to achieve a net profit for 2018 of $1.22 million and increasing it by $150,000 for 2019.

3. You assume that the Ingleburn building can be sold for $1.9 million in the year 2028, and at any point in time the equipment will have a resale value of $650,000. In ten years’ time Freedom assumes that it will have cash holdings of $12 million. You note the ATO regulation that all non-current assets be depreciated to zero.

a) Identify the cash flows at the start

b) Identify the cash flows over the life

c) Identify the cash flows at the end

Answer 1

Assets	Fair value	Depreciation pa = FV/ project term in years
Installation	1,80,000	18000
Upgradation cost	50,000	5000

P+I calculation	2018	2019	2020	2021	2022	2023	2024	2025	2026	2027	2028
Principal to be paid pa	1,00,000	1,00,000	1,00,000	1,00,000	1,00,000	1,00,000	1,00,000	1,00,000	1,00,000	1,00,000	3,00,000
Principal left = Previous Principal left - Principal to be paid	12,00,000	11,00,000	10,00,000	9,00,000	8,00,000	7,00,000	6,00,000	5,00,000	4,00,000	3,00,000	-
Interest paid = Pricipal left * i%	48,000	44,000	40,000	36,000	32,000	28,000	24,000	20,000	16,000	12,000	12,000
Payment on long term debt = Interest + Principal to be paid	1,48,000	1,44,000	1,40,000	1,36,000	1,32,000	1,28,000	1,24,000	1,20,000	1,16,000	1,12,000	3,12,000

Tax calculation	2018	2019	2020	2021	2022	2023	2024	2025	2026	2027	2028
Net income	12,20,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000
Principal + Interest to be paid	1,48,000	1,44,000	1,40,000	1,36,000	1,32,000	1,28,000	1,24,000	1,20,000	1,16,000	1,12,000	3,12,000
Taxable income (Net income - Interest paid)	10,72,000	13,56,000	13,60,000	13,64,000	13,68,000	13,72,000	13,76,000	13,80,000	13,84,000	13,88,000	11,88,000
Tax (@20%)	2,14,400	2,71,200	2,72,000	2,72,800	2,73,600	2,74,400	2,75,200	2,76,000	2,76,800	2,77,600	2,37,600

	Cashflow statement
	2018	2019	2020	2021	2022	2023	2024	2025	2026	2027	2028
Operating activities
Net income	12,20,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000
Principal + Interest to be paid	1,48,000	1,44,000	1,40,000	1,36,000	1,32,000	1,28,000	1,24,000	1,20,000	1,16,000	1,12,000	3,12,000
Less: Tax (@30%)	2,14,400	2,71,200	2,72,000	2,72,800	2,73,600	2,74,400	2,75,200	2,76,000	2,76,800	2,77,600	2,37,600
Add: depreciation expense
Installation asset	18000	18000	18000	18000	18000	18000	18000	18000	18000	18000	18000
Upgradation cost as aseet	5000	5000	5000	5000	5000	5000	5000	5000	5000	5000	5000
Total	8,80,600	11,07,800	11,11,000	11,14,200	11,17,400	11,20,600	11,23,800	11,27,000	11,30,200	11,33,400	9,73,400
Investing activities
Sale of Building											19,00,000
Beginning cash flow	0	8,80,600	19,88,400	30,99,400	42,13,600	53,31,000	64,51,600	75,75,400	87,02,400	98,32,600	1,09,66,000
Ending cash flow	8,80,600	19,88,400	30,99,400	42,13,600	53,31,000	64,51,600	75,75,400	87,02,400	98,32,600	1,09,66,000	1,20,00,000