Question

The shipping costs, sales tax, installation cost for the RBT500 will be $120,000. The equipment itself will cost $380,000. The operating and maintenance costs for the equipment is anticipated to be $30,000 per year escalating at the rate of inflation of 3% per year.

The company’s tax rate is 30%. If the annual receipts are as shown in the table below and using a straight line depreciation what is the company’s anticipated before and after tax profit per year. Note, the salvage value of the equipment is expected to be $50,000 at the end of the 10^thyear.

Before Tax Net Cash Flow?

After Tax Net Cash Flow?

After Tax Rate of Return?

Discuss these results and compare to the previous analysis:

What is different?

Which is better for the company to use, Straight Line or SOYD depreciation?

What ramifications do depreciation and tax credits have on the IRR?

new equipment for its Maintenance Overhaul and Repair (MRO) station that will increase the throughput and allow them to meet anticipated demand for the next 10 years. This equipment is the RBT500 Robotics platform which has proven to be highly reliable when installed at the company’s other divisions.

EOY	Investments	Annual Receips	Annual O&M	Annual Depreciation	Before Tax NCF	Taxes	After Tax NCF
0	($500,000)	$0	$0	$0	($500,000)	$0	($500,000)
1		$200,000	($30,000)	($45,000)	$125,000	($37,500)	$87,500
2		$250,000	($30,900)	($45,000)	$174,100	($52,230)	$121,870
3		$300,000	($31,827)	($45,000)	$223,173	($66,952)	$156,221
4		$300,000	($32,782)	($45,000)	$222,218	($66,665)	$155,553
5		$300,000	($33,765)	($45,000)	$221,235	($66,370)	$154,864
6		$350,000	($34,778)	($45,000)	$270,222	($81,067)	$189,155
7		$400,000	($35,822)	($45,000)	$319,178	($95,754)	$223,425
8		$350,000	($36,896)	($45,000)	$268,104	($80,431)	$187,673
9		$200,000	($38,003)	($45,000)	$116,997	($35,099)	$81,898
10	$50,000	$150,000	($39,143)	($45,000)	$115,857	($34,757)	$81,100

EOY	Annual Receipts
0	0
1	$200,000.00
2	$250,000.00
3	$300,000.00
4	$300,000.00
5	$300,000.00
6	$350,000.00
7	$400,000.00
8	$350,000.00
9	$200,000.00
10	$150,000.00

If the company’s MARR is 15%

Answer 1

Case:1. Present value of cash flows if depreciation is calculated based on straight line method is $433,181.82. below are the calculations,

Year	Investments	Annual Receips	Annual O&M	Annual Depreciation	Before Tax NCF	Taxes	After Tax NCF	ADD depreciaion	Total cash flows	PVF @15%	PV of cash flows
0	($500,000)	$0	$0	$0	($500,000)	$0	($500,000)	$0	($500,000)	1	(500,000.00)
1		$200,000	($30,000)	($45,000)	$125,000	($37,500)	$87,500	$45,000	$132,500	0.870	115,217.39
2		$250,000	($30,900)	($45,000)	$174,100	($52,230)	$121,870	$45,000	$166,870	0.756	126,177.69
3		$300,000	($31,827)	($45,000)	$223,173	($66,952)	$156,221	$45,000	$201,221	0.658	132,306.14
4		$300,000	($32,782)	($45,000)	$222,218	($66,665)	$155,553	$45,000	$200,553	0.572	114,666.60
5		$300,000	($33,765)	($45,000)	$221,235	($66,371)	$154,865	$45,000	$199,865	0.497	99,367.98
6		$350,000	($34,778)	($45,000)	$270,222	($81,067)	$189,155	$45,000	$234,155	0.432	101,231.84
7		$400,000	($35,822)	($45,000)	$319,178	($95,753)	$223,425	$45,000	$268,425	0.376	100,910.75
8		$350,000	($36,896)	($45,000)	$268,104	($80,431)	$187,673	$45,000	$232,673	0.327	76,061.15
9		$200,000	($38,003)	($45,000)	$116,997	($35,099)	$81,898	$45,000	$126,898	0.284	36,072.30
10	$50,000	$150,000	($39,143)	($45,000)	$115,857	($34,757)	$81,100	$45,000	$126,100	0.247	31,169.97
											433,181.82

Case:2. Present value of cash flows if depreciation is calculated based on SOYD method is = $441,428.93. Below are the calculations,

Year	Investments	Annual Receips	Annual O&M	Annual Depreciation	Before Tax NCF	Taxes	After Tax NCF	ADD depreciaion	Total cash flows	PVF @15%	PV of cash flows
0	($500,000)	$0	$0	$0	($500,000)	$0	($500,000)	$0	($500,000)	1	(500,000.00)
1		$200,000	($30,000)	(81,818.18)	$88,182	($26,455)	$61,727	$81,818	$143,545	0.870	124,822.13
2		$250,000	($30,900)	(66,942.15)	$152,158	($45,647)	$106,510	$66,942	$173,453	0.756	131,155.12
3		$300,000	($31,827)	(54,770.85)	$213,402	($64,021)	$149,382	$54,771	$204,152	0.658	134,233.49
4		$300,000	($32,782)	(44,812.51)	$222,405	($66,722)	$155,684	$44,813	$200,496	0.572	114,634.44
5		$300,000	($33,765)	(36,664.78)	$229,570	($68,871)	$160,699	$36,665	$197,364	0.497	98,124.76
6		$350,000	($34,778)	(29,998.46)	$285,224	($85,567)	$199,656	$29,998	$229,655	0.432	99,286.17
7		$400,000	($35,822)	(24,544.19)	$339,634	($101,890)	$237,744	$24,544	$262,288	0.376	98,603.72
8		$350,000	($36,896)	(20,081.61)	$293,022	($87,907)	$205,116	$20,082	$225,197	0.327	73,617.39
9		$200,000	($38,003)	(16,430.41)	$145,567	($43,670)	$101,897	$16,430	$118,327	0.284	33,635.93
10	$50,000	$150,000	($39,143)	(13,443.06)	$147,414	($44,224)	$103,190	$13,443	$116,633	0.247	28,829.85
											436,942.99

Present value of cash flows if depreciation is caluclated based on SOYD method.
Present value of cash flows		$ 436,942.99
ADD: Present value of tax benefit on sale of asset (refer note-1)		$      4,485.94
Total Present value of cash flows		$ 441,428.93

Note:1

Computation of tax benefits on loss of asset	Amount $
Original Book value of the asset	$       500,000.00
Accumulated depreciation	$    (389,506.22)
Carrying book value of the asset at the end of 10 th year	$       110,493.78
Salvage value at the end of the 10 th year	$         50,000.00
Loss on sale of asset	$         60,493.78
Tax benefits on loss of asset	$         18,148.14
Present value of tax benefits	$           4,485.94

Computation of depreciation rate under SOYD method

Step 1 – Calculate the SYD using this formula, with n representing the number of years of estimated useful life remaining as of the start of the fiscal year:

n(n + 1) / 2 = SYD

10(10+1)/2 = 55

Step 2 – Calculate the applicable fraction:

n / SYD = Applicable fraction

10/55= 18.18%

N=The estimated useful life of the asset

Step 3 – Calculate the depreciation expense:

(Cost – Salvage value) X Applicable fraction = Depreciation expense

Summary	Amount $
Present value of cash flows under SOYD method	$ 441,428.93
Present value of cash flows under Straight line Method	$ 433,181.82
Difference or incremental benefit	$      8,247.12

By Using SOYD method company will get huge tax benefits in earlier stage due to depreciation amount is high at the starting periods and will get the tax benefits on the same and organization IRR also increase.

Conclusion: Using SOYD is the better option.