Question
In: Accounting
Problem 13C-3 Income Taxes and Net Present Value Analysis [LO13-8] Lander Company has an opportunity to...
Problem 13C-3 Income Taxes and Net Present Value Analysis [LO13-8]
Lander Company has an opportunity to pursue a capital budgeting project with a five-year time horizon. After careful study, Lander estimated the following costs and revenues for the project:
| Cost of equipment needed | $ | 270,000 | ||||
| Working capital needed | $ | 64,000 | ||||
| Repair the equipment in two years | $ | 20,000 | ||||
| Annual revenues and costs: | ||||||
| Sales revenues | $ | 390,000 | ||||
| Variable expenses | $ | 200,000 | ||||
| Fixed out-of-pocket operating costs | $ | 88,000 | ||||
The piece of equipment mentioned above has a useful life of five years and zero salvage value. Lander uses straight-line depreciation for financial reporting and tax purposes. The company’s tax rate is 30% and its after-tax cost of capital is 13%. When the project concludes in five years the working capital will be released for investment elsewhere within the company
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Link for Exhibit 13B-1: https://ezto-cf-media.mheducation.com/Media/Connect_Production/bne/accounting/Garrison_16e/exhibit_13B_1.jpg
Link for Exhibit 13B-2: https://ezto-cf-media.mheducation.com/Media/Connect_Production/bne/accounting/Garrison_16e/exhibit_13B_2.jpg
Required:
1. Calculate the annual income tax expense for each of years 1 through 5 that will arise as a result of this investment opportunity.
2. Calculate the net present value of this investment opportunity. (Negative amounts should be indicated by a minus sign. Round your final answers to the nearest whole dollar.)
| 1. | Income tax expense | |
| Year 1 | ? | |
| Year 2 | ? | |
| Year 3 | ? | |
| Year 4 | ? | |
| Year 5 | ? | |
| 2. | Net present value | ? |
Solutions
Expert Solution
| Solution 1: | |||||
| Computation of Income tax expense - Lander Company | |||||
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Sales revenues | $3,90,000.00 | $3,90,000.00 | $3,90,000.00 | $3,90,000.00 | $3,90,000.00 |
| Variable expenses | $2,00,000.00 | $2,00,000.00 | $2,00,000.00 | $2,00,000.00 | $2,00,000.00 |
| Fixed out of operating costs | $88,000.00 | $88,000.00 | $88,000.00 | $88,000.00 | $88,000.00 |
| Repair cost of equipment | $0.00 | $20,000.00 | $0.00 | $0.00 | $0.00 |
| Depreciation | $54,000.00 | $54,000.00 | $54,000.00 | $54,000.00 | $54,000.00 |
| Income before taxes | $48,000.00 | $28,000.00 | $48,000.00 | $48,000.00 | $48,000.00 |
| Income tax expense (30%) | $14,400.00 | $8,400.00 | $14,400.00 | $14,400.00 | $14,400.00 |
| Net Income | $33,600.00 | $19,600.00 | $33,600.00 | $33,600.00 | $33,600.00 |
| Solution 2: | |||||
| Computation of annual cash inflows - Lander Company | |||||
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Net Income | $33,600.00 | $19,600.00 | $33,600.00 | $33,600.00 | $33,600.00 |
| Add: Depreciation | $54,000.00 | $54,000.00 | $54,000.00 | $54,000.00 | $54,000.00 |
| Annual cash inflows | $87,600.00 | $73,600.00 | $87,600.00 | $87,600.00 | $87,600.00 |
| Computation of NPV - Lander Company | ||||
| Particulars | Amount | Period | PV Factor | Present Value |
| Cash Outflows: | ||||
| Cost of Equipment | $2,70,000.00 | 0 | 1 | $2,70,000 |
| Working capital | $64,000.00 | 0 | 1 | $64,000 |
| Present Value of Cash Outflows (A) | $3,34,000 | |||
| Cash Inflows: | ||||
| Annual cash inflows: | ||||
| Year 1 | $87,600.00 | 1 | 0.885 | $77,526 |
| Year 2 | $73,600.00 | 2 | 0.783 | $57,629 |
| Year 3 | $87,600.00 | 3 | 0.693 | $60,707 |
| Year 4 | $87,600.00 | 4 | 0.613 | $53,699 |
| Year 5 | $87,600.00 | 5 | 0.543 | $47,567 |
| Release of working capital | $64,000.00 | 5 | 0.543 | $34,752 |
| Present Value of Cash Inflows (B) | $3,31,879 | |||
| Net Present Value (B-A) | -$2,121 |
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