Question

Simon Machine Tools Company  is evaluating purchase of a new set of specialized machine tools, with a MACRS class life of 3 years. The following information is available.

• Without projects afforded by the tools, ABC expects taxable income to be $350,000 for each of the next 3 years.

• With projects afforded by the tools, ABC expects additional taxable income of $80,000 for each of the next 3 years. The machine tools will cost $50,000 to purchase, $20,000 per year to operate, and have a salvage value of $10,000 after 3 years.

a) What additional taxable income is expected in each year from purchasing the tools?

b) What additional income taxes are expected in each year from purchasing the tools?

c) Compute the capital gains taxes due when the tools are salvaged in year 3?

d) At what MARR does this investment become unattractive?

Answer 1

a) THeadditional taxable income is expected in each year from purchasing the tools is as follows :-

As per the question, the tools will be having a life the of the asset will be 3 years as per MACRS class . So the decling balance will be 200% considering straight line method and considereing the IR convention for half year. The depreciation rates will be as  follows:-

Year - 1 :- 33.33%

Year-2 :- 44.45%

Year-3 :- 14.81%

	Year-1	Year-2	Year-3
Income from the tools	80000	80000	80000
Less:- Tools Operation cost	20000	20000	20000
Less:- Tools deprection for the year	16665	22225	7405
Additional income	43335	37775	52595

b) The additional income taxes are expected in each year from purchasing the tools are as follows :-

Considering the rate of Income taxe is 30 %

	Year-1	Year-2	Year-3
Additional income	43335	37775	52595
Tax rate @ 30%	13000.5	11332.5	15778.5

C. The capital gains taxes due when the tools are salvaged in year 3 as follows :-

Original asset value	50000
Less:- Depreciation claimed	46295
Carrying value	3705
Less:- Salavgae value	10000
Capital Gain/(Loss)	6295

D. Calculation of MARR :-

As there is no information on the discount rate, Deprecation rate considered as a discount rate.

Year	Inflow	Discount rate	PV
0	50000	1	-50000
1	60000	0.750019	45001.14
2	60000	0.479253	28755.18
3	70000	0.660786	46255.02
Present value of inflows	70011.34

NPV = R_t/ (1+i)^t

R= Net cashflow at time t

i = Discount rate

T = Time of the cash flow

NPV = R_t/ (1+i)^t

70,011.4 = 1,40,000/ (1+i)³

(1+i)³ =    140000/70011 = 1.9997

(1+i) = (1.9997)^1/3 = 1.2599

i = 25.99%.

Hence, if the MARR is less than 25.99 % , it will be unattractive.