Question

A firm with an effective income tax rate of 42 percent is interested in purchasing a new machine for $45,000. In order to pay for this asset, the firm acquired a $20,000 debt at 10 percent interest. The interest and the principal are to be paid in equal annual amounts over a 5 year period. The remaining $25,000 is from the firm’s equity capital. The minimum attractive rate of return is 10 percent (after tax). The useful life of this asset is 5 years. Income (estimated to result due to machine) is $23,000/year and annual operating expenses are estimated to be $7,300/year. The machine is in Class 8 (20 percent CAA rate, declining –balance class) and half-year rule is applicable. The investor wishes to find the present worth of after-tax cash flow and therefore to establish the feasibility of the project. Assume that the salvage after 5 years of use is equal to the Undepreciated Capital Cost (UCC) plus $1000. Use the spread sheet method (i.e. do not use CTF and CSF method).