Question

In: Finance

1. If the Company AD has an equipment with original cost $20,000,000, depreciation is 80% of...

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?

Solutions

Expert Solution

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

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