Chapter 11, Problem 3PSA

To determine

Concept introduction:

Net present value is the difference between the present value of inflow and the present value of outflows if the net present value is positive project is recommended.

Requirement 1:

Preparing 5 column table reporting following for 6 years(assuming straight line depreciation) (a)income before depreciation and tax,(b) depreciation expenses-straight line method ,(c) income taxable,(d) income tax,(e) net cash flow, it equals the amount of income before depreciation and deduct taxes.

Answer to Problem 3PSA

year	Income before depreciation 123 A	Depreciation-straight line 123 B	Income taxable 123 C	40% income taxed 123 D=C*.40	Profit after tax(PAT) 123 E=C-D	Cash flow after taxes 123 F=A-D
1	66000	9000	57000	22800	34200	43200
2	66000	18000	48000	19200	28800	46800
3	66000	18000	48000	19200	28800	46800
4	66000	18000	48000	19200	28800	46800
5	66000	18000	48000	19200	28800	46800
6	66000	9000	57000	22800	34200	43200

Explanation of Solution

year	Income before depreciation 123 A	Depreciation-straight line 123 B	Income taxable 123 C	40% income taxed 123 D = C*.40	Profit after tax(PAT) 123 E = C-D	Cash flow after taxes 123 F = A-D
1	66000	9000	57000	22800	34200	43200
2	66000	18000	48000	19200	28800	46800
3	66000	18000	48000	19200	28800	46800
4	66000	18000	48000	19200	28800	46800
5	66000	18000	48000	19200	28800	46800
6	66000	9000	57000	22800	34200	43200

To determine

Concept introduction:

Net present value is difference between present value of inflow and present value of outflows, if net present value is positive project is recommended.

Requirement 2:

To explain:

Preparing 5 column table reporting following for 6 years(assuming MACRS depreciation) (a) income before depreciation and tax,(b) depreciation expenses-straight line method ,(c) income taxable,(d) income tax,(e) net cash flow, it equals the amount of income before depreciation and deduct taxes.

Answer to Problem 3PSA

year	Income before depreciation 123 A	Depreciation-MACRS 123 B	Income taxable 123 C	40% income taxed D=C*.40	Profit after tax(PAT) 123 E=C-D	Cash flow after taxes 123 F=A-D
1	66000	18000	48000	19200	28800	46800
2	66000	28800	37200	14880	22320	51120
3	66000	17280	48720	19488	29232	46512
4	66000	10368	55632	22252.8	33379.2	43747.2
5	66000	10368	55632	22252.8	33379.2	43747.2
6	66000	5184	60816	24326.4	36489.6	41673.6

Explanation of Solution

year	Income before depreciation 123 A	Depreciation-MACRS 123 B	Income taxable 123 C	40% income taxed 123 D=C*.40	Profit after tax(PAT) 123 E=C-D	Cash flow after taxes 123 F=A-D
1	66000	18000	48000	19200	28800	46800
2	66000	28800	37200	14880	22320	51120
3	66000	17280	48720	19488	29232	46512
4	66000	10368	55632	22252.8	33379.2	43747.2
5	66000	10368	55632	22252.8	33379.2	43747.2
6	66000	5184	60816	24326.4	36489.6	41673.6

To determine

Concept introduction:

Net present value is the difference between present value of inflow and present value of outflows, if net present value is positive project is recommended.

Requirement 3:

Computation of net present value(NPV) of the investment if staright line depreciation method is used, using 10% discount rate.

Answer to Problem 3PSA

Net present value(NPV)

108521.4

Explanation of Solution

year	Cash flow after tax	Present value at 10% of 1	Net present value(NPV)
1	43200	.909090909	39272.73
2	46800	.826446281	38677.69
3	46800	.751314801	35161.53
4	46800	.683013455	31965.03
5	46800	.620921323	29059.12
6	43200	.56447393	24385.27
Total A			198521.4
Cash outflow B			90000
Net present value(NPV) A-B			108521.4

To determine

Concept introduction:

Net present value-is difference between present value of inflow and present value of outflows, if net present value is positive project is recommended.

Requirement 4:

Computation of net present value(NPV) of the investment if MAcrs depreciation method is used, using 10% discount rate.

Answer to Problem 3PSA

Net present value(NPV)

110305.7

Explanation of Solution

Year	Cash flow after tax	Present value at 10% of 1	Net present value(NPV)
1	46800	.909090909	42545.45
2	51120	.826446281	42247.93
3	46512	.751314801	34945.15
4	43747.2	.683013455	29879.93
5	43747.2	.620921323	27163.57
6	41673.6	.56447393	23523.66
Total A			200305.7
Cash outflow B			90000
Net present value(NPV) A-B			110305.7

To determine

Concept introduction:

Net present value-is difference between present value of inflow and present value of outflows, if net present value is positive project is recommended.

Requirement 5:

MARC’s depreciation method increases the net present value(NPV) of this project’s.

Answer to Problem 3PSA

Using MARCS depreciation net present value (NPV) is greater than the net present value (NPV) using straight-line depreciation as the cash flows are higher in the starting year of asset’s life under MARCS depreciation. Due to which depreciation is deducted at a larger amount leading to fewer income taxes paid in starting years.

Explanation of Solution

Using MARCS depreciation net present value (NPV) is greater than the net present value(NPV) using straight line depreciation as the cash flows are higher in the starting year of asset’s life under MARCS depreciation. Due to which depreciation are deducted at larger amount leading to less income taxes payment in starting years.