Question
In: Accounting
Lander Company has an opportunity to pursue a capital budgeting project with a five-year time horizon....
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 | $ | 420,000 | ||||
| Working capital needed | $ | 79,000 | ||||
| Repair the equipment in two years | $ | 27,500 | ||||
| Annual revenues and costs: | ||||||
| Sales revenues | $ | 540,000 | ||||
| Variable expenses | $ | 275,000 | ||||
| Fixed out-of-pocket operating costs | $ | 118,000 | ||||
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 10%. 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.)
Solutions
Expert Solution
Solution 1:
| Computation of Income tax expense - Lander Company | |||||
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Sales revenues | $540,000.00 | $540,000.00 | $540,000.00 | $540,000.00 | $540,000.00 |
| Variable expenses | $275,000.00 | $275,000.00 | $275,000.00 | $275,000.00 | $275,000.00 |
| Fixed out of operating costs | $118,000.00 | $118,000.00 | $118,000.00 | $118,000.00 | $118,000.00 |
| Repair cost of equipment | $0.00 | $27,500.00 | $0.00 | $0.00 | $0.00 |
| Depreciation | $84,000.00 | $84,000.00 | $84,000.00 | $84,000.00 | $84,000.00 |
| Income before taxes | $63,000.00 | $35,500.00 | $63,000.00 | $63,000.00 | $63,000.00 |
| Income tax expense (40%) | $25,200.00 | $14,200.00 | $25,200.00 | $25,200.00 | $25,200.00 |
| Net Income | $37,800.00 | $21,300.00 | $37,800.00 | $37,800.00 | $37,800.00 |
Solution 2:
| Computation of annual cash inflows - Lander Company | |||||
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Net Income | $37,800.00 | $21,300.00 | $37,800.00 | $37,800.00 | $37,800.00 |
| Add: Depreciation | $84,000.00 | $84,000.00 | $84,000.00 | $84,000.00 | $84,000.00 |
| Annual cash inflows | $121,800.00 | $105,300.00 | $121,800.00 | $121,800.00 | $121,800.00 |
| Computation of NPV - Lander Company | ||||
| Particulars | Amount | Period | PV Factor | Present Value |
| Cash Outflows: | ||||
| Cost of Equipment | $420,000.00 | 0 | 1 | $420,000 |
| Working capital | $79,000.00 | 0 | 1 | $79,000 |
| Present Value of Cash Outflows (A) | $499,000 | |||
| Cash Inflows: | ||||
| Annual cash inflows: | ||||
| Year 1 | $121,800.00 | 1 | 0.909 | $110,716 |
| Year 2 | $105,300.00 | 2 | 0.826 | $86,978 |
| Year 3 | $121,800.00 | 3 | 0.751 | $91,472 |
| Year 4 | $121,800.00 | 4 | 0.683 | $83,189 |
| Year 5 | $121,800.00 | 5 | 0.621 | $75,638 |
| Release of working capital | $79,000.00 | 5 | 0.621 | $49,059 |
| Present Value of Cash Inflows (B) | $497,052 | |||
| Net Present Value (B-A) | -$1,948 |
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