Question

A research firm is considering an investment in research equipment. The initial cost of the equipment is $10 million. The annual benefits beginning in year one and for the following five years are: $400,000, $1,600,000, $3,520,000, $2,752,000, $1,152,000, $576,000 respectively. Develop an after-tax cash flow table using MACRS depreciation and calculate the before-tax and after-tax rate of return assuming a 28 percent combined income tax rate.

Answer 1

3 Total Before Tax Rate of Return Year Before Tax Cash $ -1,00,00,000 $ flow 4,00,000 $ 16,00,000 $ 35,20,000 $ 27,52,000 $ 1,15,20,000 $ 5,76,000 $ 1,03,68,000 Before tax rate of return (IRR) 18.87% Using IRR Function 0 -1,00,00,000 $ 1 4,00,000 $ 2 16,00,000 3 35,20,000 $ 4 27,52,000 $ 5 1,15,20,000 $ 6 5,76,000$ Total 1,03,68,000 $ $ 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 100.00% Year Before Tax Cash flow MACRS 2 Depreciation Rate for 5 years Equip. Depreciation = 3 Initial Investment depreciation Rate EBIT = Before Tax 4 Cash Flow less Depreciation $ 20,00,000$ 32,00,000 $ 19,20,000 $ 11,52,000 $ 11,52,000 $ 5,76,000 $ 1,00,00,000 $ - 16,00,000$ -16,00,000 $ 16,00,000 $ 16,00,000 $ 1,03,68,000 $ - $ 68,30,250 5 Tax = EBIT*Tax Rate 6 EATEEBIT -Tax 7 Depreciation After Tax Cash Flow $ $ $ -1,00,00,000 $ $ 16,00,000 $ 20,00,000 $ 4,00,000 $ $ -16,00,000 $ 32,00,000 $ 16,00,000 $ - $ 16,00,000 $ 19,20,000 $ 35,20,000 $ - $ 16,00,000 $ 11,52,000 $ 27,52,000$ 29,03,040 $ 74,64,960 $ 11,52,000 $ 86,16,960 $ - $ $ 5,76,000$ 5,76,000 $ 26,63,798 41,66,453 6,69,750 48,36,203 $ After Tax Cash Flow rate of Return (IRR) 14.94% Using IRR Function We havn't considered Tax in Year 1 to 4 as the Income is NIL after setting off losses of prior year, however alternative assumption can be taken, below mentioned 6 Total 0 -1,00,00,000 $ 1 4,00,000 $ 2 16,00,000 $ 3 35,20,000 $ 4 27,52,000 $ 5 1,15,20,000 $ $ 5,76,000 $ Alternative Solution: Year Before Tax Cash flow MACRS 2 Depreciation Rate for 5 years Equip. 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 100.00% Depreciation = 3 Initial Investment * depreciation Rate $ 20,00,000 $ 32,00,000 $ 19,20,000 $ 11,52,000$ 11,52,000 $ 5,76,000$ 1,00,00,000 EBIT = Before Tax 4 Cash Flow less Depreciation - 16,00,000 $ - 16,00,000 $ 16,00,000 $ 16,00,000 $ 1,03,68,000 $ - $ 68,30,250 5 Tax = EBIT*Tax Rate 6 EATEEBIT -Tax 7 Depreciation After Tax Cash Flow | $ | $ $ -1,00,00,000$ -4,48,000 $ - 11,52,000 $ 20,00,000 $ 8,48,000 $ -4,48,000 $ - 11,52,000 $ 32,00,000 $ 20,48,000 $ 4,48,000 $ 11,52,000 $ 19,20,000 $ 30,72,000 $ 4,48,000 $ 11,52,000 $ 11,52,000 $ 23,04,000$ 29,03,040 $ 74,64,960 $ 11,52,000 $ 86,16,960 $ - $ - $ 5,76,000$ 5,76,000$ 26,63,798 41,66,453 6,69,750 48,36,203 $ After Tax Cash Flow rate of Return (IRR) 15.48% Using IRR Function Nominal difference in IRR as mentioned above Let me know, if you have any questions over comments section, rate positive if you are satisfied with the solution