Question

Madeleiene has been operating a restaurant and café in an old building downtown. Because of her cafe's popularity and the cafe's old kitchen, she has had trouble keeping up with demand for her famous croissants. Due to the success of her business, Madeleine has been approved for a loan of $60,000 to cover the cost of a new oven, walk-in freezer, industrial refrigerator, and industrial coffee machine. The new kitchen appliances will drastically lower her operating costs and will raise receipts by making the café more efficient. Consequently, real net returns will increase by $15,000 per year. Madeleine has assumed an investment life of 5 years, straight-line depreciation of 7 years, an inflation rate of 3%, a risk premium of 1%, a required rate of return of 10%, marginal tax rate of 24% and a real terminal value of $32,000. What is the nominal pre-tax terminal value? a $32,000 b.$37,096.77 c.$38,256.04 d.$33,942.25 What is the after-tax, risk adjusted discount rate? a.8.36% b.9.12% c.10.64% d.7.94% What is the accumulated depreciation after 5 years? a $60,000 b.$30,000 c.$37,500 d.$42,857.14 What are the tax savings from depreciation? a $8,571.43 b $2,057.14 c. $7,500 alla

Answer 1

Facts of the given case : Life of the asset is 7 years, Inflation rate 3%, Risk premium is 1%, Expected rate is 10%, tax rate is 24%, salvage value is $32,000

1. Nominal Pre-tax terminal value would be : $32,000 (1+0.03)^6 = $37,096
   
2. After tax RADR is : (Normal Return + Risk Premium ) x (1 - 0.24)
   i,e, (10 + 1 ) x 0.76 = 8.36%
   
3. Accumulated depreciation is calculated below
   Depreciation is arrived using SLM method which is (60,000)/7 x 5 = $42,857
   
4. Annual Tax savings on depreciation is calculated below
   Depreciation charged during the year x tax rate i.e.  

   8,571.43 x 0.24 = 2,057 per year

   
   Please share your feedback