In: Accounting
Lander Company has an opportunity to pursue a capital budgeting project with a five-year time horizon. After careful study, Lander estimated the following costs and revenues for the project:
Cost of equipment needed | $ | 280,000 | ||||
Working capital needed | $ | 65,000 | ||||
Repair the equipment in two years | $ | 20,500 | ||||
Annual revenues and costs: | ||||||
Sales revenues | $ | 400,000 | ||||
Variable expenses | $ | 205,000 | ||||
Fixed out-of-pocket operating costs | $ | 90,000 | ||||
The piece of equipment mentioned above has a useful life of five years and zero salvage value. Lander uses straight-line depreciation for financial reporting and tax purposes. The company’s tax rate is 40% and its after-tax cost of capital is 12%. When the project concludes in five years the working capital will be released for investment elsewhere within the company
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. Calculate the annual income tax expense for each of years 1 through 5 that will arise as a result of this investment opportunity.
2. Calculate the net present value of this investment opportunity. (Negative amounts should be indicated by a minus sign. Round your final answer to nearest whole dollar.)
1 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |||||
Sales (A) | 400000 | 400000 | 400000 | 400000 | 400000 | |||||
Less: costs | ||||||||||
Variable expenses | 205000 | 205000 | 205000 | 205000 | 205000 | |||||
Fixed out-of-pocket operating costs | 90000 | 90000 | 90000 | 90000 | 90000 | |||||
Repairs | 0 | 20500 | 0 | 0 | 0 | |||||
Depreciation | (280000/5) | 56000 | 56000 | 56000 | 56000 | 56000 | ||||
Total (B) | 351000 | 371500 | 351000 | 351000 | 351000 | |||||
Income before taxes | (A-B) | 49000 | 28500 | 49000 | 49000 | 49000 | ||||
Annual income tax expenses @ 40% | 19600 | 11400 | 19600 | 19600 | 19600 | |||||
2 | Net present value | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |||
Income before taxes | 49000 | 28500 | 49000 | 49000 | 49000 | |||||
Less: Annual income tax expenses | 19600 | 11400 | 19600 | 19600 | 19600 | |||||
Net income | 29400 | 17100 | 29400 | 29400 | 29400 | |||||
Add: depreciation | 56000 | 56000 | 56000 | 56000 | 56000 | |||||
Annual cash inflow | 85400 | 73100 | 85400 | 85400 | 85400 | |||||
Initial investment | -280000 | |||||||||
Working capital | -65000 | 65000 | ||||||||
Net cashflow | -345000 | 239400 | 186100 | 239400 | 239400 | 304400 | ||||
Discount factor @12% | 1 | 0.892857 | 0.797194 | 0.71178 | 0.635518 | 0.567427 | ||||
Discounted cashflow | -345000 | 213750 | 148358 | 170400 | 152143 | 172725 | ||||
Net present value | 512376 | |||||||||