Question

Bill is considering acquiring a ship that costs $40,000. It is estimated that the ship will generate additional revenues of $20,000 per year for 5 years. The ship will be depreciated over 5 years utilizing the straight line method. Bill faces a 28% average income tax rate and an 8% minimum acceptable return on all investments.

1. Compute the annual additional revenues after-tax. Show your work.

2. Compute the annual depreciation expense. Show your work.

3. Compute the tax savings from the annual depreciation expense. Show your work.

4. Compute the after tax net present value. Show your work.

Answer 1

1) the annual additional revenues after-tax =Additional revenue (1-Tax rate)

                             = 20000 ( 1-.28)

                             = 20000* .72

                             = 14400

2)Annual depreciation expense =Cost/useful life

                = 40000/5

                = 8000

3)Tax saving from annual depreciation =Annual depreciation expense*tax rate

                    = 8000 * 28%

                     = 2240

4)Annual cash flow = after tax additional revenue +Tax saving from annual depreciation

             = 14400 +2240

              = 16640

present value of annual cash flow =PVA8%,5 *Annual cash flow

             = 3.99271 * 16640

          = 66438.69

NPV =Present value - initial cost

= 66438.69 -40000

= 26438.69 (rounded to 26439)

#Find PVA from present value annuity table at 8% for 5 periods or using the formula :[1/(1+i)^1+ 1/(1+i)^2+....1/(1+i)^5]