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The Mecca Company is planning to purchase a new machine at a cost of $660,000, which will depreciate on a straight-line...

The Mecca Company is planning to purchase a new machine at a cost of $660,000, which will depreciate on a straight-line basis over a 10-year period with $60,000 salvage value and a full year's depreciation taken in the year of acquisition. The new machine is expected to produce average annual before-tax net cash inflows of $132,000 a year in each of the next 10 years. The tax rate is 40%. The unadjusted rate of return would be: A. 12%. B. 13.8%. C. 13.4%. D. 11.3%

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Answer #1

Calculation of Depreciation :

New machine cost -   $660,000

Salvage value -   $60,000

Estimated life of the asset - 10 years .

Depreciation =[ Cost of the machine - salvage value ] / Estimated life of the asset .

= [$660,000 - $60,000]/10   

= $60,000.

Calculation of Unadjusted Rate of Return :

Annual before-tax net cash inflows $1,32,000
(-) Depreciation $60,000
Cash flows before tax $72,000
(-) Tax @40 % $28,800
Cash flows after tax $43,200

Unadjusted Rate of Return = cash flows after tax / Average Investment.

= $43,200/$3,30,000

= 13.09%.

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