Question

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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?

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 = BC**	E	F = 1/(1+10%)^n	*G = EF**
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

jeff jeffy answered 2 years ago

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