Question

beta corp wants to invest $10M in new equipment to enhance its manufacturing process. This will result in additional (taxable) cash inflows of $1.1M annually for the next 15 years.The equipment will be depreciated over 10 years (no savage value. Assume a current corporate tax rate of 34% and a discount rate of 5%. Evaluate this investment for each of the following four situations: a. Marginal tax rate will decrease to 25% at the end of year 5. b. the marginal tax rate will increase to 40% at end of year 10. c. the equipment will not last for 15 years but only for 12 years. d. the benefit from the investment is $1.2M per year instead of $1.1M per year.

Answer 1

ans a
	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15
Cash flows	($10)	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10
Less: Depreciation (10/10)		1	1	1	1	1	1	1	1	1	1
Net increase in income N		$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$1.10	$1.10	$1.10	$1.10	$1.10
Tax rate T		34%	34%	34%	34%	25%	25%	25%	25%	25%	25%	25%	25%	25%	25%	25%
Income after tax N*(1-T%)		0.066	0.066	0.066	0.066	0.075	0.075	0.075	0.075	0.075	0.075	0.825	0.825	0.825	0.825	0.825
Add: depreciation		1	1	1	1	1	1	1	1	1	1
Total cash flows	($10)	1.066	1.066	1.066	1.066	1.075	1.075	1.075	1.075	1.075	1.075	0.825	0.825	0.825	0.825	0.825
Discount factor 5%	1	0.9524	0.9070	0.8638	0.8227	0.7835	0.7462	0.7107	0.6768	0.6446	0.6139	0.5847	0.5568	0.5303	0.5051	0.4810
Discounted cash flow	($10)	$1.015	$0.967	$0.921	$0.877	$0.842	$0.802	$0.764	$0.728	$0.693	$0.660	$0.482	$0.459	$0.438	$0.417	$0.397
NPV (total of all)	$0.462
ans b
	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15
Cash flows	($10)	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10
Less: Depreciation (10/10)		1	1	1	1	1	1	1	1	1	1
Net increase in income N		$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$1.10	$1.10	$1.10	$1.10	$1.10
Tax rate T		34%	34%	34%	34%	34%	34%	34%	34%	34%	40%	40%	40%	40%	40%	40%
Income after tax N*(1-T%)		0.066	0.066	0.066	0.066	0.066	0.066	0.066	0.066	0.066	0.06	0.66	0.66	0.66	0.66	0.66
Add: depreciation		1	1	1	1	1	1	1	1	1	1
Total cash flows	($10)	1.066	1.066	1.066	1.066	1.066	1.066	1.066	1.066	1.066	1.06	0.66	0.66	0.66	0.66	0.66
Discount factor 5%	1	0.9524	0.9070	0.8638	0.8227	0.7835	0.7462	0.7107	0.6768	0.6446	0.6139	0.5847	0.5568	0.5303	0.5051	0.4810
Discounted cash flow	($10)	$1.015	$0.967	$0.921	$0.877	$0.835	$0.795	$0.758	$0.722	$0.687	$0.651	$0.386	$0.368	$0.350	$0.333	$0.317
NPV (total of all)	($0.018)
ans c
	0	1	2	3	4	5	6	7	8	9	10	11	12
Cash flows	($10)	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10	$1.10
Less: Depreciation (10/10)		1	1	1	1	1	1	1	1	1	1
Net increase in income N		$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10	$1.10	$1.10
Tax rate T		34%	34%	34%	34%	34%	34%	34%	34%	34%	34%	34%	34%
Income after tax N*(1-T%)		0.066	0.066	0.066	0.066	0.066	0.066	0.066	0.066	0.066	0.066	0.726	0.726
Add: depreciation		1	1	1	1	1	1	1	1	1	1
Total cash flows	($10)	1.066	1.066	1.066	1.066	1.066	1.066	1.066	1.066	1.066	1.066	0.726	0.726
Discount factor 5%	1	0.9524	0.9070	0.8638	0.8227	0.7835	0.7462	0.7107	0.6768	0.6446	0.6139	0.5847	0.5568
Discounted cash flow	($10)	$1.015	$0.967	$0.921	$0.877	$0.835	$0.795	$0.758	$0.722	$0.687	$0.654	$0.424	$0.404	$0.000	$0.000	$0.000
NPV (total of all)	($0.940)
ans d
	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15
Cash flows	($10)	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20	$1.20
Less: Depreciation (10/10)		1	1	1	1	1	1	1	1	1	1
Net increase in income N		$0.20	$0.20	$0.20	$0.20	$0.20	$0.20	$0.20	$0.20	$0.20	$0.20	$1.20	$1.20	$1.20	$1.20	$1.20
Tax rate T		34%	34%	34%	34%	34%	34%	34%	34%	34%	34%	34%	34%	34%	34%	34%
Income after tax N*(1-T%)		0.132	0.132	0.132	0.132	0.132	0.132	0.132	0.132	0.132	0.132	0.792	0.792	0.792	0.792	0.792
Add: depreciation		1	1	1	1	1	1	1	1	1	1
Total cash flows	($10)	1.132	1.132	1.132	1.132	1.132	1.132	1.132	1.132	1.132	1.132	0.792	0.792	0.792	0.792	0.792
Discount factor 5%	1	0.9524	0.9070	0.8638	0.8227	0.7835	0.7462	0.7107	0.6768	0.6446	0.6139	0.5847	0.5568	0.5303	0.5051	0.4810
Discounted cash flow	($10)	$1.078	$1.027	$0.978	$0.931	$0.887	$0.845	$0.804	$0.766	$0.730	$0.695	$0.463	$0.441	$0.420	$0.400	$0.381
NPV (total of all)	$0.846
The best situation is Option D as it produces highest NPV