Question

Perez Electronics is considering investing in manufacturing equipment expected to cost $310,000. The equipment has an estimated useful life of four years and a salvage value of $ 18,000. It is expected to produce incremental cash revenues of $155,000 per year. Perez has an effective income tax rate of 40 percent and a desired rate of return of 10 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

a.Determine the net present value and the present value index of the investment, assuming that Perez uses straight-line depreciation for financial and income tax reporting.

b.Determine the net present value and the present value index of the investment, assuming that Perez uses double-declining-balance depreciation for financial and income tax reporting.

d.Determine the payback period and unadjusted rate of return (use average investment), assuming that Perez uses straight-line depreciation.

e.Determine the payback period and unadjusted rate of return (use average investment), assuming that Perez uses double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when determining the unadjusted rate of return.)

Answer 1

Answer a)

Year	Cash revenue	Depreciation	EBT	Tax (40%)	EAT	Cash flows (EAT+ DEP.)
1	155,000	73000	82000	32800	49200	122200
2	155,000	73000	82000	32800	49200	122200
3	155,000	73000	82000	32800	49200	122200
4	155,000	73000	82000	32800	49200	122200
	Straight line Deprication = 310000-18000/4 =73000
Year	Cash flow	Present value @ 10	Present value of cash flow
1	122200	0.91	111079.80
2	122200	0.83	100937.20
3	122200	0.75	91761.09
4	122200	0.68	83419.17
		Total P.V.	387197.26
		Cost of Project	310,000
		NPV	77197.26

Answer b)  

1^st Year   -     Straight-line Depreciation Rate = 1 ÷ 4 = 0.25 = 25%
Declining Balance Rate = 2 × 25% = 50%
Depreciation = 50% × $310,000 = $155,000

2^nd Year   Declining Balance Rate = 50%
Book Value = Cost ? Accumulated Depreciation = $310,000 ? $155,000 = $155000
Depreciation = 50% × $155,000 = $77500

3 rd Year   Declining Balance Rate = 50%
Book Value = Cost ? Accumulated Depreciation = $$155,000 ? $77500= $77500
Depreciation = 50% × $77500= $38750

^4th Year   Declining Balance Rate = 50%
Book Value = Cost ? Accumulated Depreciation = $ 77500? $ 38750= $38750

Depreciation = 50% × $38750= $19375

Year	Cash revenue	Depreciation	EBT	Tax (40%)	EAT	Cash flows (EAT+ DEP.)
1	155,000	155,000	0	32800	-32800	40200
2	155,000	77500	77500	32800	44700	117700
3	155,000	38750	116250	32800	83450	156450
4	155,000	19375	135625	32800	102825	175825

Year	Cash flow	Present value @ 10	Present value of cash flow
1	40200	0.91	36541.80
2	117700	0.83	97220.20
3	156450	0.75	117479.73
4	175825	0.68	120025.99
		Total P.V.	371267.72
		Cost of Project	310,000
		NPV	61267.72

Answer d)

Year	Cash revenue	Depreciation	EBT	Tax (40%)	EAT	Cash flows (EAT+ DEP.)
1	155,000	73000	82000	32800	49200	122200
2	155,000	73000	82000	32800	49200	122200
3	155,000	73000	82000	32800	49200	122200
4	155,000	73000	82000	32800	49200	122200

Payback period for 2 years = 122200+122200 = 244400

Cash flow for the 3rd year = 122200

Payback period = 2 years +310000-244400/122200*12= 6.4 months

Total payback period 2 years and 6.4 mn.

Answer e)

Year	Cash revenue	Depreciation	EBT	Tax (40%)	EAT	Cash flows (EAT+ DEP.)
1	155,000	155,000	0	32800	-32800	40200
2	155,000	77500	77500	32800	44700	117700
3	155,000	38750	116250	32800	83450	156450
4	155,000	19375	135625	32800	102825	175825

Payback period for 2 years = 40200+117700= 157900

Cash flow for the 3rd year = 156450

Payback period = 2 years + 310000-157900/156450*12= 11.7 months

Total payback period is 2 years and 11.7 mn