Question

ht-Line Depreciation A salad oil bottling plant can either buy caps for the glass bottles at 5e each or install $500, 000 worth of plastic molding equipment and manufac- ture the caps at the plant. The manufacturing engi- neer estimates the material, labor, and other costs would be 3e per cap (a) If 11 million caps per year are needed and the molding equipment is installed, what is the payback period? (b) The plastic molding equipment would be depreciated by straight-line depreciation using a 6-year useful life and no salvage value. Assuming a combined 26 % income tax rate, what is the after-tax payback period, and what is the after-tax rate of return?

Answer 1

(a) Calculation of payback period -

Worth of plastic molding equipment = $500000

Cost of cap for glass bottle if purchased from market = $ 0.05

Cost of manufacturing of cap through molding equipment = $ 0.03

Effective saving in cost of cap by using molding equipment = $ 0.02

Yearly requirement of caps = 11000000 nos

Yearly cost saving using molding equipment = 11000000 x 0.02 = $ 220000

Payback period for molding equipment will be = 500000/220000 = 2.27 years

Hence answer will be 2.27 years.

(b) (i) Calculation of payback period after considering income tax on depreciation -

Cost of molding equipment = $500000

Saving of Income Tax on depreciation in 6 years @ 26% per annum = $500000 x 26% = $130000

(Note - Depreciation in 6 years with no salvage value at per straight line method will be $ 500000)

Effective cost of molding equipment after saving of Income Tax = $500000 - $130000 = $370000

Payback period of molding equipment will be = 370000/220000 = 1.68 years

Hence answer will be 1.68 years

(b) (ii) Calculation of rate of return after considering income tax on depreciation -

Total savings on using of molding plant in 6 years = Cap manufactured per year x Saving per Cap x No of Years

= 11000000 x 0.02 x 6 = $1320000

Cost of molding equipment after tax = $500000- $130000 = $370000

Rate of Return = $1320000 (tital Saving)/$370000 (cost of equipment)/6 (no of years) x 100 = 59.46%

Hence answer will be 59.46%

Answer 2

Answers from the book: a.) 2.27 yrs, b.) 3.02 yrs with RoR = 28.82%

So the answer above is correct for a., but the answers listed for b. are completely garbage. The answers I'm referring to are 1.68 yrs with RoR = 59.46%. Dumb.

Answer 3

The answer for b. in the back of the book is incorrect. b.) Payback period = 2.71 years, RoR = 28.90%.

BTCF: $220k

Depreciation: $83,333

Taxable income: $136,667

Tax (26%): $35,533

ATCF: $184,467

PBP: Expense/Annual Benefit = $500k/$184,467 = 2.71 yrs

RoR: NPW = $184,467(P/A, RoR, 6) - $500k = 0

Try 25% (App C)

Try 30% (App C)

interpolate.