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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