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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 2 years ago
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