Question

Problem 1 Evergreen Corporation, a calendar year, accrual basis taxpayer, requires a new piece of equipment for use in its manufacturing business. The company would like to determine whether it would be cost beneficial to invest in the equipment and has asked you to determine the present value of the after-tax cost of purchasing the equipment. The equipment will cost $80,000 and qualifies as a 3 year asset under the MACRS classification. Evergreen would use the equipment for 3 years. At the end of the three years, Evergreen estimates that it could sell the equipment for $15,000. Assume that bonus depreciation and the Sec. 179 expensing option are not available. Calculate the present value of after-tax cash flows that would result if Evergreen purchases the equipment. Assume a 4% discount rate. Assume that the cash payment for the machine occurs at the beginning of year 1, and all other cash flows, including tax costs and benefits, occur on the last day of the year. Before consideration of this purchase, Evergreen estimates that its marginal tax rate will be 21% for the next five years. Hint: Consider the effects of the cash payment for the asset, cash flow from the sale of the asset, and tax effects of any income, deduction, gain, or loss related to the equipment. Evergreen's present value of after-tax cash flows:

Answer 1

Answer:

Evergreen's Present value of after-tax cash flows = -$53,858.51 or ($53,858.51)

Working:

Cash payment of machine occurs at the beginning of year; this can be taken as End of Year 0 cash outflow

Year Cost of Equipment ($80,000.00) Depreciation rate Depreciation Expense Depreciation tax shield 33.33% 44.45% 14.81% ($26,664.00) ($35,560.00) ($11,848.00) $5,599.44 $7,467.60 $2,488.08 $26,664.00 $62,224.00 Accumulated Depreciation Book value at the end of year 3 Salvage value Gain Tax on gain Salvage value net of tax $74,072.00 $5,928.000 $15,000.000 $9,072.000 ($1,905.12) $13,094.88 $5,599.44 $7,467.60 $15,582.96 Cash flows Present value of cash flows ($80,000.00) ($53,858.51)

Above excel with 'show formula' is as below:

-80000 0.3333 0.4445 0.1481 =$B$2*04 =$B$2*D4 =$B$2*E4 =C5 -21% =D5*-21% =E5-21% 1 Year 2 Cost of Equipment 3 4 Depreciation rate 5 Depreciation Expense 6 Depreciation tax shield 7 8 Accumulated Depreciation 9 Book value at the end of year 3 10 Salvage value 11 Gain 12 Tax on gain 13 Salvage value net of tax --C5 =C8-D5 =D8-E5 --(B2+E8) 15000 =E10-E9 =E11*-21% =E10+E12 =B2 =C6 =D6 =E6+E13 15 Cash flows 16 Present value of cash flows 17