Question

Bloomington Manufacturing Company is considering the purchase of equipment to expand its productive capacity. The equipment is expected to generate the following cash revenues and expenses over its useful life. Year 1 2 BLOOMINGTON MANUFACTURING COMPANY DATA FOR CAPITAL BUDGETING ANALYSIS-EQUIPMENT Cash Revenues Cash Expenses s 30,000$ 40,000 50,000 40,000 30,000 20,000 22,000 25,000 20,000 20,000 5 The cost of the equipment is $60,000 and the equipment is expected to have a salvage value of $6,000. The company uses 200% (double) declining balance depreciation for all equipment. The company requires a minimum rate of return after tax of 11% and a maximum payback period of 4 years on its capital investment purchases. The company has a marginal tax rate of 30%. REQUIRED: (1) What is the after tax accounting rate of return on this equipment? Round your answer to four decimal places. What is the after tax payback period on this equipment? Round your answer to two decimal places. What is the after tax net present value of this equipment? Round your answer to the nearest whole dollar. Should the company purchase the equipment? Explain.

Answer 1

Income tax rate	30%
Expected minimum rate of return after tax is	11%
Maximum payback period	4 years
Method of depreciation	Double declining balance method
Expected useful life	5 years
Question 1 average tax rate of return
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Inflow of cash revenue		30000	40000	50000	40000	30000
Cash expenses	60000	20000	22000	25000	20000	20000
Incremental cash flow		10000	18000	25000	20000	10000
Tax		0	1080	4908	4444.8	2467.2
Net post tax inflow		10000	16920	20092	15555.2	7532.8
Post tax accounting rate of return		17%	28%	33%	26%	13%
Average annual income	14020	(5 years average net post tax inflows)
Investment	60000
Average rate of return	23.3667%

Calculation of tax		Year 1	Year 2	Year 3	Year 4	Year 5
Profit before depreciation		10000	18000	25000	20000	10000
Depreciaion		24000	14400	8640	5184	1776
Profit after depreciation		-14000	3600	16360	14816	8224
Tax outflow		0	1080	4908	4444.8	2467.2

Calculation of depreciation
year	opening book value	dep rate	depreciation	closing book vlue
1	60000	40%	24000	36000
2	36000	40%	14400	21600
3	21600	40%	8640	12960
4	12960	40%	5184	7776
5	7776	40%	1776	6000

DEPRECIATION RATE double declining method
Calculation of the depreciation rate	.1/5	20
Double declining dep rate	.20X2	40%

Ans to Question 2 Payback period calculation
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Inflow of cash revenue		30000	40000	50000	40000	30000
Cash expenses	60000	20000	22000	25000	20000	20000
Incremental cash flow		10000	18000	25000	20000	10000
Tax		0	1080	4908	4444.8	2467.2
Net post tax inflow		10000	16920	20092	15555.2	7532.8
Payback period	3 years 10 months				62567.2

Ans to question 3 - Discount factor required to calculate the net present value of the post tax rate of return

Ans to question 4 - As the Returns satisfies the minimum average rate of return of 11%(actual rate of return is 23%) and maximum Payback period of 4 years ( Actual pay back period is below 4 years) Bloomington can go ahead on this proposed capital investment.