Kaylie-Cole-Sept3

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Jan 9, 2024

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Kaylie Cole **Investment Analysis for Marker's Tattoo Studio** Investing in new equipment is a pivotal decision for any business, impacting its operations, profitability, and long-term growth prospects. Marker's Tattoo Studio is contemplating the purchase of new laser therapy equipment. This essay will comprehensively evaluate the financial aspects of this investment, including the expected increase in annual net income, the accrual accounting rate of return (AARR) based on the average investment, and whether the investment is worthwhile from a net present value (NPV) perspective. Additionally, it will explore the implications of tax considerations, depreciation methods, equipment life, and potential changes in tax authority policies. To begin, Marker's must assess the expected increase in its annual net income as a result of investing in the new laser therapy equipment. This involves analyzing the projected additional revenues and incremental costs associated with the equipment. Markers anticipates that the new equipment will generate incremental margins of $98,000 annually due to the introduction of new client services enabled by the technology. These additional revenues represent the expected financial benefit of the investment. The new equipment will also require ongoing maintenance, incurring incremental cash costs of $10,000 each year. These costs are essential to keep the equipment operational and represent a necessary expense associated with the investment. The net impact on annual net income can be calculated as follows:

Net Income = Additional Revenues - Incremental Costs Net Income = $98,000 - $10,000 = $88,000 per year This calculation reveals that Markers can anticipate an annual increase in net income of $88,000 by investing in the new laser therapy equipment. The Accrual Accounting Rate of Return (AARR) is a financial metric that helps Marker's evaluate the profitability of this investment from an accounting perspective. It takes into account the average investment over the equipment's expected life. To compute AARR, we first calculate the average investment, which is the mean of the initial investment and the estimated terminal disposal value. Average Investment = ($300,000 + $20,000) / 2 = $160,000 Next, we determine the average annual accounting profit, which is the mean net income generated by the investment over its projected life. Average Annual Accounting Profit = ($88,000 + $88,000 + $88,000 + $88,000 + $88,000) / 5 = $88,000 Now, we can calculate the AARR: AARR = (Average Annual Accounting Profit / Average Investment) x 100 AARR = ($88,000 / $160,000) x 100 ≈ 55.00%

An AARR of approximately 55.00% indicates that the investment in the new equipment is expected to yield a robust accounting-based return. Generally, when an AARR exceeding the company's minimum required rate of return (which, in this case, is 10%) this signifies a favorable investment. A fundamental aspect of evaluating the investment's attractiveness is conducting a Net Present Value (NPV) analysis. NPV considers the time value of money, providing insights into whether the investment will create value for Marker's. The NPV formula is as follows: NPV = Σ [Cash Flow / (1 + Rate of Return)^t] - Initial Investment Where: - Cash Flow represents the net cash flow for each year. - Rate of Return is the required rate of return (10% in this instance). - t signifies the year (from 1 to 5, representing the equipment's expected life). To calculate NPV, we utilize the annual cash flows generated by the new equipment: Year 1: $88,000 / (1 + 0.10)^1 = $80,000 Year 2: $88,000 / (1 + 0.10)^2 = $72,727 Year 3: $88,000 / (1 + 0.10)^3 = $66,116 Year 4: $88,000 / (1 + 0.10)^4 = $60,105 Year 5: ($88,000 + $20,000) / (1 + 0.10)^5 = $69,091

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Finally, we calculate the NPV: NPV = ($80,000 + $72,727 + $66,116 + $60,105 + $69,091) - ($300,000 + $20,000) NPV = $348,039 - $320,000 NPV = $28,039 The positive NPV of $28,039 indicates that the investment in the new laser therapy equipment is financially attractive. In other words, by undertaking this investment, Markers can anticipate generating a net gain of $28,039 in today's dollars. In Marker's evaluation of the new equipment, it's crucial to comprehend the concept of "equipment life." The life of equipment refers to the estimated duration during which the equipment is expected to be operational and productive. In this case, Marker's anticipates that the equipment will have a useful life of 5 years. A 5-year equipment life means that Marker's expects the equipment to remain in good working condition and deliver its intended benefits for five years. Beyond this period, the equipment may become less efficient, technologically outdated, or require significant maintenance, making it less economical to keep in operation. The income tax rate plays a pivotal role in the financial analysis of investments. In Marker's scenario, they operate under a 25% income tax rate. This means that for tax purposes, they need to consider the tax implications of their investment decisions.Depreciation is a significant tax consideration when investing in equipment. In this case, Marker's depreciates assets on a straight-line basis, specifically using a straight-line method to terminal value. Straight-line

depreciation allocates the cost of the equipment evenly over its useful life, including the terminal disposal value. However, this also means that depreciation remains constant throughout the equipment's life, which can affect annual tax deductions. The ability to depreciate assets down to zero is a common tax practice. It means that, for tax purposes, the business can spread the cost of the equipment over its useful life and potentially reduce taxable income. However, this may lead to higher taxable income in later years when depreciation is no longer available.Markers expects a terminal disposal value of $20,000 for the equipment at the end of its 5-year useful life. The terminal disposal value represents the estimated salvage or residual value of the equipment when it's no longer in use. It's a crucial consideration because it can offset the initial investment's cost. Suppose Marker's is contemplating the option of depreciating the new equipment down to zero over its useful life and intends to sell the equipment in 5 years. In that case, the impact of this choice on NPV hinges on several factors: - Choosing to depreciate the equipment to zero would result in higher taxable income in the earlier years of its life, as there would be no depreciation deductions available. - The decision to sell the equipment after 5 years could lead to a different tax scenario. Depending on the tax authority's policies at that time, Marker's might face capital gains taxes or other tax implications related to the equipment's sale.

-The exact impact on NPV would depend on the difference in annual tax expenses due to the depreciation method chosen and the specific tax implications associated with the sale of the equipment. Given these complexities, Marker's should collaborate with tax experts to perform a detailed analysis, factoring in potential tax law changes and the precise tax implications. This will help them make an informed decision and assess the overall NPV impact accurately. In conclusion, Marker's Tattoo Studio's decision to invest in new laser therapy equipment is promising from both financial and accounting perspectives. The expected increase in annual net income amounts to $88,000, demonstrating that the investment can significantly enhance the studio's profitability. The Accrual Accounting Rate of Return (AARR) of approximately 55.00% further supports the attractiveness of the investment.From a Net Present Value (NPV) standpoint, the positive NPV of $28,039 indicates that the investment is economically viable. By making this investment, Markers can anticipate generating a net gain in today's dollars.Moreover, understanding the concept of equipment life is crucial, as Marker's expects the equipment to remain productive for 5 years. This implies that after this period, they may need to assess whether it's still worthwhile to keep the equipment in operation. The income tax rate of 25% and the use of straight-line depreciation are significant considerations. However, the choice to depreciate the equipment down to zero should be made cautiously, considering the impact on taxable income and potential tax changes. The terminal disposal value of $20,000 is an essential factor in offsetting the initial investment. Ultimately, the

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decision to invest in the new equipment should involve collaboration with financial and tax experts to account for all variables accurately. Markers should ensure they have a comprehensive understanding of the tax implications and potential changes in tax authority policies to make a well-informed decision regarding their investment.

References Accounting rate of return references https://www.investopedia.com/terms/a/arr.asp https://www.freshbooks.com/glossary/financial/accounting-rate-of-return https://365financialanalyst.com/knowledge-hub/corporate-finance/what-is-accounting-rate-of- return/ Net present value references: https://www.investopedia.com/terms/n/npv.asp https://corporatefinanceinstitute.com/resources/valuation/net-present-value-npv/ https://www.youtube.com/watch?v=HAMx6pYV-fA https://www.youtube.com/watch?v=HFFkFMfotT0