Question

A group of businessmen formed a corporation to lease for 5 years a piece of land at the intersection of two busy streets. The corporation has invested $50,000 in car-washing equipment. They will depreciate the equipment by sum-of-years’ digits depreciation, assuming a $5,000 salvage value at the end of the 5-year useful life. The corporation is expected to have a before-tax cash flow, after meeting all expenses of operation (except depreciation), of $20,000 the first year, declining $3,000 per year in future years (second year = $17,000; third year = $14,000; etc.). The corporation is taxed at a combined corporate tax rate of 20%. If the projected income is correct, and the equipment can be sold for $5,000 at the end of the 5 years, what after-tax rate of return (to the nearest 1%) would the corporation receive from the venture?

**Please post a unique answer, not an old one. Thank you!

Answer 1

Calculation of Rate of Return on Venture:

Step 1: Calculation of Depreciation:

Sum of Years Digit Method:

As per this method we need to calculate a sum of years digit i.e. SYD which is given by the formula n(n+1)/2, where n is the useful life of the asset.

Given that n = 5 years,

therefore SYD = 5(5+1)/2 = 15.

Now,we consider depreciation for each year upon the sum of years which is 15 (1+2+3+4+5)

Depreciation schedule

Year	Remaining Useful Life (at beginning of the year)	Sum of Years Digit	Applicable Percentage	Annual Depreciation amount
1	5	5/15	33.33%	15000
2	4	4/15	26.67%	12000
3	3	3/15	20%	9000
4	2	2/15	13.33%	6000
5	1	1/15	6.67%	3000

Step 2: Computation of After Tax Rate of Return:

Year	Income per year - (1)	Depreciation (as computed above) - (2)	Cash flow (1-2)	Tax @ 20%	Net Cash flow after tax
1	20000	15000	5000	1000	4000
2	17000	12000	5000	1000	4000
3	14000	9000	5000	1000	4000
4	11000	6000	5000	1000	4000
5	8000 + 5000 = 13000 (Salvage value)	3000	10000	2000	8000
					24000

Rate of Return on Investment = Net Cash flow after Tax/Initial Investment

Rate of return on investment (%) = 24000/50000*100 = 48%