Net Present Value with Tax Effect ABC Corporation is thinking of producing and selling a new type of smoke detector They have gathered together their best estimate of anticipated costs as presented below New equipment to produce the smoke detector would cost $100,000 It would be usable for 10 years After 10 years, it would have a salvage value equal to 10 of the original cost However, for tax purposes this equipment will be treated as 5 year property based on the full cost with years worth of depreciation the first and last year ( affects 6 yrs of tax returns ) This depreciation method is called Straight Line Accelerated Cost Recovery System with year convention Production and sales of the smoke detector would require a working capital investment of $40,000 to finance accounts receivable, inventories, and date to day cash needs This working capital would be released for use elsewhere after 10 years A marketing study projects an increase in sales for 8000 units per year on average over the next 10 years The smoke detectors would sell for $45 each variable costs for production, administration, and advertising are expected to average $25 per unit The company will have advertising costs of $50,000 per year Other fixed costs for salaries, insurance, and maintenance would total $80,000 per year Excludes SL accounting depreciation The machine will need a major overhaul (repair costs) in year 7 for $20,000 Accounting depreciation book depreciation is based on cost less salvage over 10 years The companys borrowing rate is 10 before taxes They have a 40 tax rate Compute the NPV and PI Approximate the ARR and Payback Think about how to compute IRR does it appear to be higher or lower than the discount rate used change rate until you get ZERO NPV How to attack the problem First figure out what the recurring every year revenue and expenses are w out depreciation and summarize in a subtotal Put basic items in a list then make a second pass through the list deciding whether the each listed item has a tax effect Also do tax effect for depreciation depreciation was not a cash flow, but its tax savings is a cash flow Then apply appropriate PV factors

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Net Present Value with Tax Effect. ABC Corporation is thinking of producing and selling a new type of smoke detector. They have gathered together their

Net Present Value with Tax Effect. ABC Corporation is thinking of producing and selling a new type of smoke detector. They have gathered together their best estimate of anticipated costs as presented below.

New equipment to produce the smoke detector would cost $100,000. It would be usable for 10 years. After 10 years, it would have a salvage value equal to 10% of the original cost. However, for tax purposes this equipment will be treated as 5 year property based on the full cost with years worth of depreciation the first and last year (affects 6 yrs of tax returns). This depreciation method is called Straight Line Accelerated Cost Recovery System with year convention.
Production and sales of the smoke detector would require a working capital investment of $40,000 to finance accounts receivable, inventories, and date to day cash needs. This working capital would be released for use elsewhere after 10 years.
A marketing study projects an increase in sales for 8000 units per year on average over the next 10 years:
The smoke detectors would sell for $45 each; variable costs for production, administration, and advertising are expected to average $25 per unit.
The company will have advertising costs of $50,000 per year.
Other fixed costs for salaries, insurance, and maintenance would total $80,000 per year. Excludes SL accounting depreciation.
The machine will need a major overhaul (repair costs) in year 7 for $20,000.
Accounting depreciation book depreciation is based on cost less salvage over 10 years.
The companys borrowing rate is 10% before taxes. They have a 40% tax rate.

Compute the NPV and PI. Approximate the ARR and Payback. Think about how to compute IRR does it appear to be higher or lower than the discount rate used change rate until you get ZERO NPV. How to attack the problem: First figure out what the recurring every year revenue and expenses are w/out depreciation and summarize in a subtotal. Put basic items in a list then make a second pass through the list deciding whether the each listed item has a tax effect. Also do tax effect for depreciation depreciation was not a cash flow, but its tax savings is a cash flow. Then apply appropriate PV factors.