Question
In: Accounting
Lander Company has an opportunity to pursue a capital budgeting project with a five-year time horizon....
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 | $ | 310,000 | ||||
| Working capital needed | $ | 68,000 | ||||
| Repair the equipment in two years | $ | 22,000 | ||||
| Annual revenues and costs: | ||||||
| Sales revenues | $ | 430,000 | ||||
| Variable expenses | $ | 220,000 | ||||
| Fixed out-of-pocket operating costs | $ | 96,000 | ||||
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.
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 answer to nearest whole dollar.)
Solutions
Expert Solution
Here, a special explanation of treatement of Repair expenses is to be considered. Repair of machine is a revenue expenditure which restores its decreased utility but does not increase its capacity or utility. Hence such expenses are written off against the sales revenue of the year in which such expenses are incurred.
Hence tax expenses will change for year - 2 only. Since repair expenses are incurred in year - 2 only.
Thus tax expenses will be Year - 1 15600, Year - 2 will be 9000 and for each of Year - 3 , 4 and 5 tax expenses will be 15600 per year.
| Year - 1 | Year - 2 | Year 3.4&5 | |
| Sales revenues | 430000 | 430000 | 430000 |
| (-) Variable expenses | 220000 | 220000 | 220000 |
| Contribution | 210000 | 210000 | 210000 |
| (-) Fixed cost ( cash expenses) | 96000 | 118000 | 96000 |
| Income before Depreciation | 114000 | 92000 | 114000 |
| (-) Depreciation | 62000 | 62000 | 62000 |
| Income before tax | 52000 | 30000 | 52000 |
| Tax expenses | 15600 | 9000 | 15600 |
NPV OF THE INVESTMENT OPPURTUNITY
| Year | CF | DF | PV |
| 0 | -310000 | 1 | -378000 |
| 1 | 98400 | 0.88496 | 87079.65 |
| 2 | 83000 | 0.78315 | 65001.17 |
| 3 | 98400 | 0.69305 | 68196.14 |
| 4 | 98400 | 0.61332 | 60350.56 |
| 5 | 166400 | 0.54276 | 90315.25 |
| NPV | - 7057.23 |
CF = cash flows are calculated as under
| Year - 1 | Year - 2 | Year - 3 | Year - 4 | Year - 5 | |
| Income before tax | 52000 | 30000 | 52000 | 52000 | 52000 |
| (-) Tax expenses @ 30% of above | 15600 | 9000 | 15600 | 15600 | 15600 |
| Profit after tax | 36400 | 21000 | 36400 | 36400 | 36400 |
| (+) Depreciation ( 310000 / 5 years) | 62000 | 62000 | 62000 | 62000 | 62000 |
| (+) Working capital recovery | 68000 | ||||
| Net Cash flow | 98400 | 83000 | 98400 | 98400 | 166400 |
ekkarill92 answered 1 year agoRelated Solutions
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