Review Exercises

1. The following information pertains to a machine recently sold by Powers Enterprises:

Net initial investment

$300,000

Estimated useful life for tax purposes

8 years

Terminal disposal value for tax purposes

zero

Age at the time of sale

6 years

Cash received from the sale

$60,000

Income tax rate

30%

Assuming Powers uses straight-line depreciation and is a profitable company, calculate the after-tax cash flow from the sale of the machine.

2. (CMA adapted) Jasper Company has a payback requirement of three years on new equipment acquisitions. A new sorter is being evaluated that costs $450,000 and has an estimated useful life of five years. Straight-line depreciation will be used with a zero terminal disposal value. Jasper is subject to a 40% income tax rate.

Calculate the amount of savings in after-tax annual cash operating costs that must be generated by the new sorter to meet the companys payback requirement.

3. (Appendix) Massey Companys nominal rate of return for capital-budgeting projects is 20%, which includes a 10% inflation rate. The present value of $1 at 20% for one year is 0.833. Assume a 40% income tax rate.

Calculate the after-tax present value (expressed in nominal dollars) of:

a. Before-tax cash operating savings of $100,000 (expressed in year 0 dollars) to be received at the end of year 1.

b. Year 1 depreciation of $70,000.