Question

Consider the five items that follow, which are related to independent investment opportunities. Purchase price of a new machine: $870,000 Annual straight-line depreciation: $85,000 Annual savings in cash operating costs: $140,000 Advertising expenses related to a new marketing campaign in year 2: $45,000 Sale of an asset in year 6: Loss on sale, $70,000; proceeds received by seller, $33,000

Required: Complete the following table, inserting the (pre-discounted) cash flow amounts that would be used in a net-present-value analysis. Column A should be completed based on the assumption of no income taxes; in contrast, Column B should be completed assuming the relevant company is subject to a 30% income tax rate. Be sure to note cash outflows in parentheses.

	Column A: No Income Taxes Column B: 30% Tax Rate Purchase price of new machine Annual straight-line depreciation Annual savings in cash operating costs Advertising expenses Sale of Asset

Answer 1

	Column A: No Income Taxes	Column B: 30% Tax Rate	Remarks
Purchase price of new machine	$                                (870,000)	$                         (870,000)	Purchase price does not offer any tax benefit or a consequence so the purchase price will remain the same in both scenarios.
Annual straight-line depreciation		$                             25,500	85000*30%, Depreciation does not involve cash flow but will be taken to profit and loss as the expense and hence will save tax of 30%.
Annual savings in cash operating costs	$                                  140,000	$                             98,000	140000*70%, 30% tax will be paid on this revenue
Advertising expenses-2nd year	$                                    45,000	$                             31,500	45000*70%, the expense will be the deductible expense and hence will save tax of 30% so effective cash flow out of pocket will be only 70%
Sale of Asset	$                                    33,000	$                             54,000	As calculated below
Loss on sale		$                             70,000
This loss is deductible in profit and loss so tax benefit @ 30%		$                             21,000
Cash sale price		$                             33,000
Total cash benefit		$                             54,000