Question

2) Queens Corporation (QC) purchases a $5 million machine. The machine will be depreciated by $1 million per year over 5 years, starting this year. Suppose QC's tax rate is 25%. a) What impact will the cost of the purchase have on earnings during the first year? b) What impact will the cost of the purchase have in the firm's cash flow during the first year? 3) A philanthropist wants to fund a prize to be awarded annually in perpetuity starting one year after she dies. The market interest rate is 5%. a) If she wanted the cash award to be $20,000, how much would she need to fund her prize? if she wanted the prizes to grow by 2.5% per year (perhaps to keep up with inflation. and the first prize was still $20,000, how much would she need to leave? b)

Answer 1

2 . a) Depreciation cost of the machine = $1 million per year

Cost of the machine = $5 million

Therefore, actual value of the machine after 1 year = $5-$1= $4 million

therefore, total earning of the Queens Corporation will be reduced by $4 million each year

b) Tax rate = 25% & total cost of the Queens Corporation in 1 year = $4 million

Income tax rate = 25%, therefore, taxable income after 1 year = Gross earnings- Total cost = (x-4) (If gross earnings = x million per year)

Net earnings of the Queens Corporation =0.75*(x-4) = 3/4(x-4)

3. a) Market interest rate = 5% Prize amount = $20,000

let investment = P

then 20000= P(1+.05)

or, P = 20000/1.05 = $19047.61, which is required money she needs to invest for prize after 1 year.

b) Growth rate of prize = 2.5%

therefore, prize amount after 1 year = $20000*1.025= $20500

let investment = P

therefore, 20500= P(1+.05)

    P = 20500/1.05 = 19523.80, which is the required money she needs to leave for prize.