Question

A manufacturer of fabricated metal products has acquired a new plasma table for $37,000. It is projected that the acquisition of this equipment will increase revenue by $10,000 per year. Operating costs for the machine will average $2,600 per year. The machine will be depreciated using the MACRS method, with a recovery period of 7 years. The company uses an after-tax MARR rate of 10% and has an effective tax rate of 30%.

2. Now, suppose that the duration of the project is six years and that an estimate of the value of the equipment cannot be obtained from the marketplace.

2.5. What conclusion can be drawn by comparing the results of the before- and after-tax analyses?

Answer 1

Analysis before tax

Year	0	1	2	3	4	5	6
Revenue		$10,000	$10,000	$10,000	$10,000	$10,000	$10,000
Operating costs		$2,600	$2,600	$2,600	$2,600	$2,600	$2,600
Net cash flows	-$37,000	$7,400	$7,400	$7,400	$7,400	$7,400	$7,400
Cost of capital	$1	$0.875	$0.765	$0.670	$0.586	$0.513	$0.448
PV of cash flows	-$37,000	$6,474	$5,664	$4,956	$4,336	$3,793	$3,319
NPV	-$8,459

Here the cost of capital has been taken as 14.3% which is the pre tax cost of capital

Pretax MARR = 10% / 0.7 = 14.3%

After tax analysis

Year	0	1	2	3	4	5	6
Revenue		$10,000	$10,000	$10,000	$10,000	$10,000	$10,000
Operating costs		$2,600	$2,600	$2,600	$2,600	$2,600	$2,600
Depreciation		$5,287	$9,061	$6,471	$4,621	$3,304	$3,300
Operating income		$2,113	-$1,661	$929	$2,779	$4,096	$4,100
Taxes		$634	-$498	$279	$834	$1,229	$1,230
Net income		$1,479	-$1,163	$650	$1,945	$2,867	$2,870
Operating cash flows		$6,766	$7,898	$7,121	$6,566	$6,171	$6,170
Net cash flows	-$37,000	$6,766	$7,898	$7,121	$6,566	$6,171	$6,170
Cost of capital	$1	$0.909	$0.826	$0.751	$0.683	$0.621	$0.564
PV of cash flows	-$37,000	$6,151	$6,528	$5,350	$4,485	$3,832	$3,483
NPV	-$7,171

Hence, we see that the NPV value has increased in after tax analysis as compared to before tax analysis. This is due to the tax benefits received on depreciation.