Question

XYZ Co. wants to get a special instrument to control a critical step in their production line. The instrument has an acquisition cost of $25,000 and will lead to a savings of $10,000 per year for 5 years. They want to evaluate different methods of financing the acquisition. Assume that if they buy it they will use MACRS depreciation for 3-year property. Their effective income tax rate is 44%, and their after-tax MARR is 16%. The rest of the corporation is profitable.

What's the present worth of the after-tax cash-flow stream if they buy it using a loan for the full amount at 8% interest (assume annual payments)?

Answer 1

Refer the table for calculation of ATCF

BTCF is provided

Depreciation rate = 33.33%, 44.45%, 14.81% and 7.41% respectively for the first four years.

Depreciation = Rate × Price

Taxable income = BTCF - Depreciation

Tax = 44% of Taxable income.

ATCF = BTCF - Tax

Now we have already calculated the ATCF. We can Calculate the PW of ATCF at a rate of 16%.

Second case when company borrowed $ 25,000 at a rate of 8% for 5 years. Calculate the annual payment

A = 25,000(A/P,8%,5) = 25,000 + 0.25045 = $ 6261.41

Refer below the loan amortization schedule

Now calculating the after tax cash flow

Taxable income = BTCF - Depreciation - Interest

Tax = 0.44 × taxable income

From above calculation we see the firms investment by taking loan. The NPW is negative therefore it is not a good / profitable investment when we borrow.