Question

Mars Inc. is considering the purchase of a new machine that costs $60,000. This machine will reduce manufacturing costs by $5,000 annually. Mars will use the MACRS accelerated method (shown below) to depreciate the machine, and it expects to sell the machine at the end of its 5-year life for $10,000. The firm expects to be able to reduce net operating working capital by $15,000 when the machine is installed, but the net working capital will return to the original level when the project is over (i.e., after 5 years). Mars's marginal tax rate is 40 percent, and it uses a 12 percent cost of capital to evaluate projects of this nature.

Year	MACRS Percentage
1	0.20
2	0.32
3	0.19
4	0.12
5	0.11
6	0.06

Calculate the net cash flows of the project. Be sure to put the cash flows in the order, i.e., CF0 in blank 1, CF1 in blank 2, CF2 in blank3, etc. Cash outflows should be negative numbers, e.g., -23,500.

Blank 1
Blank 2
Blank 3
Blank 4
Blank 5
Blank 6

Which of the following events is likely to encourage a company to raise its target debt ratio?

Question 13 options:

	An increase in the corporate tax rate.
	An increase in the personal tax rate.
	An increase in the company's operating leverage.
	Statements a and c are correct.
	All of the statements above are correct.

Answer 1

The cash flow for years 1-6 are as below :

depreciation is a tax-deductible expense, and hence results in tax savings. This is equivalent to a cash inflow (as it is a reduction in cash outflow of tax).  Depreciation tax shield in each year = depreciation * tax rate

net cash flow in year 0 = initial investment - reduction in working capital

net cash flow in years 1 to 4 = reduced manufacturing costs + depreciation tax shield

net cash flow in year 5 = reduced manufacturing costs + depreciation tax shield - increase in working capital + net cash from sale of machine

net cash from sale of machine in year 5 = sale price * (1 - tax rate)

net cash flow in year 6 = depreciation * tax rate

An increase in the corporate tax can likely encourage a company to raise its target debt ratio. This is because interest payments are tax-deductible, and higher debt would result in higher interest payments, and therefore more tax savings. This would results in higher returns for equity shareholders

an increase in personal tax rate has no effect on a company's decision to change its target debt ratio.

An increase in the company's operating leverage (proportion of fixed costs to variable costs) would result in more pressure on the company's earnings. This would discourage the company from raising its debt, as the interest payments would put further pressure on the company's earnings.

The first option is the correct on - increase in corporate tax rate