Question

Green House Tomato Company is considering the purchase of new processing equipment for $1,500,000, with an additional installation cost of $18,000. The new equipment will result in earnings before interest and taxes of $450,000 per year, and to operate the equipment properly, workers would have to go through an initial training session costing the company $50,000. In addition, because the equipment is extremely efficient, its purchase necessitates an increase in inventory of $90,000. Assume the company uses straight-line depreciation, the equipment has an expected life of seven years, the equipment will have no salvage value, the marginal tax rate is 28 percent, and the company has a required rate of return of 12 percent.

What are the annual after-tax cash flows associated with the equipment for years one through six?

Answer 1

Annual after-tax cash flows Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Earnings before interest and tax $450,000 $450,000 $450,000 $450,000 $450,000 $450,000 Tax at 28% $126,000 $126,000 $126,000 $126,000 $126,000 $126,000 Net Income after tax $324,000 $324,000 $324,000 $324,000 $324,000 $324,000 Add: Depreciation $216,857 $216,857 $216,857 $216,857 $216,857 $216,857 Annual cash inflows $540,857 $540,857 $540,857 $540,857 $540,857 $540,857 Release of Working capital Salvage value after tax Annual after-tax cash flows $540,857 $540,857 $540,857 $540,857 $540,857 $540,857 Initial outlay (year) Cost of the equipment Installation cost Working capital - Inventory Training cost Initial outlay (year o). $1,500,000 $18,000 $90,000 $50,000 $1,658,000 Depreciation charge Cost of asset Life of asset Annual depreciation expense $1,518,000 a 7lb $216,857 a/b