Question

Winthrop Company has an opportunity to manufacture and sell a new product for a five-year period. To pursue this opportunity, the company would need to purchase a piece of equipment for $160,000. The equipment would have a useful life of five years and zero salvage value. It would be depreciated for financial reporting and tax purposes using the straight-line method. After careful study, Winthrop estimated the following annual costs and revenues for the new product: Annual revenues and costs: $390,000 $215,000 $ 89,000 Sales revenues Variable expenses Fixed out-of-pocket operating costs The company's tax rate is 30% and its after-tax cost of capital is 17%. Click here to view Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using tables. Required: 1. Calculate the annual income tax expense that will arise as a result of this investment. 2. Calculate the net present value of this investment opportunity. (Round your final answer to nearest whole dollar.) 1. Annual income tax expense 2. Net present value

Answer 1

Computation of Annual Income Tax
	Now	Year 1	Year 2	Year 3	Year 4	Year 5
Sales revenues		$390,000	$390,000	$390,000	$390,000	$390,000
Less: Variable expenses		$215,000	$215,000	$215,000	$215,000	$215,000
Less: Fixed out-of-pocket operating costs		$89,000	$89,000	$89,000	$89,000	$89,000
Less: Depreciation (160000 / 5)		$32,000	$32,000	$32,000	$32,000	$32,000
Profit Before tax (a)		$54,000	$54,000	$54,000	$54,000	$54,000
Tax (aX30%)		$16,200	$16,200	$16,200	$16,200	$16,200
Computation of Net Present Value
	Now	Year 1	Year 2	Year 3	Year 4	Year 5
Profit Before Tax		$54,000	$54,000	$54,000	$54,000	$54,000
Less: Tax (aX30%)		$16,200	$16,200	$16,200	$16,200	$16,200
PAT (a)		$37,800	$37,800	$37,800	$37,800	$37,800
Depreciation (160000 / 5) (b)		$32,000	$32,000	$32,000	$32,000	$32,000
Annual Cash Flow (a+b)		$69,800	$69,800	$69,800	$69,800	$69,800
Cash outflow	-$160,000
Net Cash Flow	-$160,000	$69,800	$69,800	$69,800	$69,800	$69,800
PVF @17%	1	0.854700855	0.730513551	0.624370556	0.533650048	0.456111152
Present Value	-$160,000	$59,658	$50,990	$43,581	$37,249	$31,837
Net Present Value	$63,314