Question

The Greentree Lumber Company is attempting to evaluate the profitability of adding another cutting line to its present sawmill operations. They would need to purchase two more acres of land for ​$30,000 ​(total). The equipment would cost$122,000 and could be depreciated over a​ five-year recovery period with the MACRS method. The new equipment is expected to increase gross revenue by ​$51,000 per year for five​ years, and operating expenses will be $14,000 annually for five years. It is expected that this cutting line will be closed down after five years. The​ firm's effective income tax rate is 54​%. If the​ company's after-tax MARR is 3​% per​ year, is this a profitable​ investment? Assume that land recovered at original cost of ​$30,000 at the end of five years. The market value of equipment is negligible at the end of year 5.

Answer 1

Solution :-

Working note (1) :-

Year	Dep %	Dep per year
1	20%	24400
2	32%	39040
3	19.20%	23424
4	11.52%	14054.4
5	11.52%	14054.4
Salvage	5.76%	7027.2

Working Note (2) :-

Salvage Value Loss		7027.20
Tax Saving on Loss		3794.69
After Tax Salavge Loss		3232.51

Net Cashflow statement :-

Year	0	1	2	3	4	5
Machine Cost	-122000
Land Cost	-30000
Incremental revenue		51000	51000	51000	51000	51000
Less :- Incremental Exps		-14000	-14000	-14000	-14000	-14000
Less :- Dep		-24400	-39040	-23424	-14054.4	-14054.4
Net Income		12600	-2040	13576	22945.6	22945.6
Less :- Tax @54%		-6804	1101.6	-7331.04	-12390.6	-12390.6
Income After tax		5796	-938.4	6244.96	10554.98	10554.98
Add :- Dep		24400	39040	23424	14054.4	14054.4
Cashflows		30196	38101.6	29668.96	24609.38	24609.38
Land Cost Recovered						30000
Loss on Salvage Value after tax						-3232.51
Total Net Cashflows	-152000	30196	38101.6	29668.96	24609.38	51376.87
PVF@3%	1	0.970874	0.942596	0.915142	0.888487	0.862609
PV of Cashflows	-152000	29316.5	35914.41	27151.3	21865.11	44318.14
NPV = Sum of PV of Cashflows	6565.466
As The NPV is Positive So Accept the Proposal

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