In: Finance
1. If the Company AD has an equipment with original cost $20,000,000, depreciation is 80% of the cost of equipment, and the book value is $4,000,000. At the end of its physical life time year, if the Company can sell the equipment for $5,000,000 in the market, what is the gain on sale? What is the after tax (AT) net salvage value if the tax rate is 40%?
2.For two projects A and B, both have initial capital outlay of $20,000 at T=0, Project A has 6 year physical life time with annual cash flow of $6,000. Project B has 3 year physical life time with same $6,000 annual cash flow. If the discount rate is 10%, which project should be chosen if using EEA (Equivalent Annual Annuity) approach to calculate?
Question 1:
Book value of equipment = $4,000,000
Sale value of equipment = $5,000,000
Gain on sale = Sale value of equipment - Book value of equipment
= $5,000,000 - $4,000,000
= $1,000,000
Tax on sale = Gain on sale * tax rate
= $1,000,000 * 40%
= $400,000
After tax net salvage value = Sale value of equipment - Tax on sale
= $5,000,000 - $400,000
= $4,600,000
Gain on sale is $1,000,000
After tax net salvage value is $4,600,000
Question 2:
Calculation of EAA of Projects | ||||||
Year | Project A | Project B | ||||
Cash Flows | Discount Factor @10% | Discounted Cash Flows | Cash Flows | Discount Factor @10% | Discounted Cash Flows | |
A | B | C = 1/(1+10%)^n | D = B*C | E | F = 1/(1+10%)^n | G = E*F |
0 | -20,000 | 1 | -20000 | -20,000 | 1 | -20000 |
1 | 6,000 | 0.877192982 | 5263.157895 | 6,000 | 0.877192982 | 5263.157895 |
2 | 6,000 | 0.769467528 | 4616.805171 | 6,000 | 0.769467528 | 4616.805171 |
3 | 6,000 | 0.674971516 | 4049.829097 | 6,000 | 0.674971516 | 4049.829097 |
4 | 6,000 | 0.592080277 | 3552.481664 | 0.592080277 | 0 | |
5 | 6,000 | 0.519368664 | 3116.211986 | 0.519368664 | 0 | |
6 | 6,000 | 0.455586548 | 2733.519286 | 0.455586548 | 0 | |
NPV | 3332.005099 | -6,070.207837 | ||||
Equivalent Annual Annuity for Project A = [r * NPV] / [1 - (1+r)^-n] | ||||||
= [10% * $3,332.005099] / [1 - (1+10%)^-6] | ||||||
= $333.2005099 / 0.43552607 | ||||||
= $765.052961 | ||||||
= $765.05 | ||||||
Equivalent Annual Annuity for Project A = [r * NPV] / [1 - (1+r)^-n] | ||||||
= [10% * -$6,070.207837] / [1 - (1+10%)^-3] | ||||||
= -$607.0207837 / 0.24868519 | ||||||
= -$2,440.920432 | ||||||
= -$2,440.92 | ||||||
EAA of Project A is $765.05 | ||||||
EAA of Project B is -$2,440.92 | ||||||
EAA of Project A is higher than EAA of Project B | ||||||
Hence Project A should be choosed |