Question

# The summit petroleum Corporation will purchase an asset that qualifies for three year MACRS depreciation. The...

The summit petroleum Corporation will purchase an asset that qualifies for three year MACRS depreciation. The cost is \$430,000 in the ass that will provide the following stream of earnings before depreciation and taxes for the next four years:

Year 1: \$200,000
Year 2: 245000
Year 3: 84,000
Year 4: 76,000

The firm is in a 40% tax bracket and has a cost of capital of 12%.

A. Calculate the net present value. Use the formula and financial calculator methods.

B. Under the net present value method, should summit petroleum Corporation purchase the asset?

Table 12-12 Depreciation percentages (expressed in decimals) Depreciation 3-Year 5-Year 7-Year 10-Year 15-Year 20-Year MACRS MACRS MACRS MACRS MACR MACRS 5 Year 0.200 0.143 0.100 0.050 0.038 0.072 0.067 0.062 0.1150.089 0.092 0.069 0.057 0.053 0.045 2 3 0.445 0.320 0.245 0.180 0.095 0.148 0.192 0.1750.144 0.086 0.077 0.074 0.115 0.125 0.115 0.089 0.089 0.058 0.074 0.066 0.062 0.059 0.0450.0660.0590.045 0.0590.045 0.045 0.0590.045 0.045 0.0590.045 0.045 0.0590.045 0.045 0.045 0.045 0.045 0.065 0.065 0.033 0.059 12 13 14.. 0.059 0.059 0.030 16.. 19 20 0.045

Statement showing depreciation

 Year Opening balance Depreciation rates Depreciation Closing balance 1 430000 33.30% 143190 286810 2 286810 44.50% 191350 95460 3 95460 14.80% 63640 31820 4 31820 7.40% 31820 0

Statement showing NPV

 Particulars 0 1 2 3 4 NPV Cost of Machine -430000 Earning before depreciation and tax 200000 245000 84000 76000 Depreciation -143190 -191350 -63640 -31820 PBT 56810 53650 20360 44180 Tax @40% 22724 21460 8144 17672 PAT 34086 32190 12216 26508 Add: depreciation 143190 191350 63640 31820 Cash flow -430000 177276 223540 75856 58328 PVIF @ 12% 1.0000 0.8929 0.7972 0.7118 0.6355 PV -430000 158282 178205 53993 37068 -2452

A) NPV = -2452\$

B) No, the firm should not purchase the asset since NPV is negative

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