CAPITAL BUDGETING: APPLICATIONS

Homework Assignment: FINEBERG FINANCIAL SERVICES

Fineberg Financial Services is a large and profitable firm that provides bookkeeping and tax services to its clients. It plans to invest $85,000 in a new computer system to increase its data handling, analysis, and reporting capacity. The system will be installed and operational in the third quarter of the current fiscal year. At the end of the fifth year, Fineberg expects to sell the computer system for $5,000.

The firms consultants estimate that the new equipment will increase the firms annual net operating income before depreciation and taxes by $30,000 for the first year of its operation, $45,000 for the second year, and $50,000 for the third, fourth, and fifth years.

The investment will be made at the beginning of the companys current fiscal year, and the additional income each year is to be treated as being received at the ends of each year.

Fineberg's cost of capital is 10.5% per year. The reinvestment rate will be 11.5%.

Finebergs combined federal, state, and local tax rate on regular income is 40%. The tax rate on capital gains or losses is 25%.

For tax purposes, Fineberg will use the Modified Accelerated Cost Recovery Schedule (MACRS) for computer equipment and other property with a 5-year life. The MACRS percentages for years 1-5 are 15%, 34%, 20.40%, 12.24%, and 11.30%, respectively.

You can use Figure 13-1 as a beginning template for this problem.

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In your answers to the following, format dollar values to the nearest whole dollar, format percentages with one decimal place, and format the years to break even with two decimal places.

1. How much income tax will Fineberg pay each year on the incremental operating income generated by the new computer system?

2. What are the after-tax net present values, internal rates of return, and modified internal rates of return at the end of each year of the 5-year period? Format dollar values to the nearest whole dollar, and format rates of return as percentages with one or two decimal places.

3. How many years will it take the investment to break even, based on the discounted cash flows?