You must evaluate a proposal to buy a new milling machine. The purchase price of the milling machine, including shipping and installation costs, is $105,000, and the equipment will be fully depreciated at the time of purchase. The machine would be sold after 3 years for $72,000. The machine would require a $9,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $45,000 per year. The marginal tax rate is 25%, and the WACC is 8%. Also, the firm spent $4,500 last year investigating the feasibility of using the machine. a. How should the $4,500 spent last year be handled? I. Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. II. The cost of research is an incremental cash flow and should be included in the analysis. III. Only the tax effect of the research expenses should be included in the analysis. IV. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay. V. Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. -Select- b. What is the initial investment outlay for the machine for capital budgeting purposes after the 100% bonus depreciation is considered, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. Round your answer to the nearest dollar. $ c. What are the project's annual cash flows during Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar. Year 1: $ Year 2: $ Year 3: $ d. Should the machine be purchased? -Select- Imagine that while cleaning out your great-grandfather's attic, you find a rucksack containing a journal and a sheaf of papers. Your great-grandfather, a noted entrepreneur and businessman, was also an accomplished amateur explorer. The journal, which appears to be written in your great- grandfather's hand, is a diary describing a series of visits to a small uncharted island called Rodos, in the northern Atlantic during the late 1800s. The journal and papers contain notes made during his conversations with Valdimar, king of Rodos, when they discussed the kingdom's business and economic conditions. ger Notes-February 1, 1878 Background on the Kingdom and Economy of Rodos Rodos is a small agrarian island Kingdom. Most Rodosian citizens live in small towns or in rural areas. King Valdimar and his royal court, on the other hand, live in the country's single, geographically centralized city. King Valdimar, an enlightened ruler, wants to create an economy that improves Rodosians' standard of living and quality of life. He is also concerned with being as fair as he can to each citizen. The king has vast property holdings, but he does allow his citizens to own real and personal property, which can be used to generate the income to improve their standard of living and to pay their taxes. Tax revenues are used to provide for the island's defense and general services, such as a postal system and the construction and maintenance of roads, bridges, and similar structures. Financial markets are rudimentary but effective. Citizens and businesses with more income than they require may deposit their funds into banks, who in turn may lend these funds to qualified borrowers. Rodos's equity markets are more constrained; owners are not allowed to sell more than 49% ownership of their company. So, though equity markets exist, there aren't many companies nor large numbers of shares bought and sold. Selected Provisions of the Rodosian Tax Code King Valdimar's current tax regime, both personal and corporate, is intended to be fair to everyone. The personal tax assesses the same tax-2,400 sodors (SR) per year-on each person, regardless of circumstance (rich or poor) or station (member of court, businessman, craftsman, or fisherman). The taxable income of all businesses-regardless of form (proprietorship, partnership, or corporation)-is subject to a 12% tax rate. . Neither interest on borrowed funds nor dividends on outstanding shares are allowed to be paid using pre-tax income. Normal operating expenses, however, are tax-deductible. As you read through the journal notes, you decide to take the rucksack to your finance class tomorrow to enhance the class discussion of the effect of taxes on decision making. However, to ensure that you are ready for this discussion, you've prepared and answered the following outline of topics and questions to be addressed. (Hint: For a brief reminder of relevant terms, click on the Definitions tab. Also, don't confuse the behaviors of the average Rodosian with your own-particularly when attempting to predict future behaviors.) Term Definitions Description The income that remains after the deduction of taxes and other mandatory charges. This balance is available for spending or saving as desired. Disposable income Definitions Term Disposable income Excise tax Luxury tax Flat tax system Description The income that remains after the deduction of taxes and other mandatory charges. This balance is available for spending or saving as desired. This tax, which is levied on the consumption of certain products, is frequently included in the price of the product. A tax levied on products or services that are deemed to be unnecessary, excessive, or nonessential to a normal standard of living. Also called a proportional tax system, this scheme requires each taxpayer to pay the same tax rate. An example of a flat rate is a sales tax. This tax scheme imposes lower tax rates on less affluent taxpayers and higher tax rates on wealthier taxpayers. This scheme requires each taxpayer to pay the same dollar amount regardless of income. An example of a regressive tax is a user fee for a bridge or toll road. This tax is levied on products or services that the government perceives as vices. This tax, which also generates additional government revenue, is intended to discourage the consumption of these goods or services without making their use illegal. Progressive tax system Regressive tax system Sin tax I. What general observations can be made regarding tax systems in general and the Rodosian tax code? A. In general, there are three different types of tax systems: progressive, regressive, and flat tax systems. The existing Rodosian system imposed on individual (personal) taxpayers is an example of a system. One benefit of the existing system is that it increases the kingdom's tax base because every citizen pays taxes; as a result, every taxpayer should care about how King Valdimar spends his tax revenue. However, as the wealth or income of an individual taxpayer decreases, the proportion of his or her income or wealth spent on taxes B. In contrast, the existing system imposed on businesses is an example of a system. A benefit of this arrangement is that all business organizations-regardless of income or asset holdings-pay the same II. How does the current tax system affect the decisions, behaviors, and condition of an individual Rodosian citizen and/or business? A. In general, taxes are classified as and both an individual's disposable income and a business's after-tax profits. B. An advantage of the existing personal tax requirement is that it allows an individual Rodosian to keep of his or her income as his or her total income increases. The requirement of a constant annual tax payment of SR2,400 means that as his or her annual income increases from SR24,000 per year to SR54,000, the proportion of his or her income lost to taxes decreases from to In general, this type of tax arrangement should be expected to the average individual Rodosian to improve his or her income and quality of life. C. A second advantage of Rodos's existing personal tax arrangement is its which makes it expensive to comply with the requirement. Everything else being equal, this characteristic tends to a citizen's disposable income. D. Similarly, an advantage of the current business tax requirement is that it is identical for all business organizations. According to this arrangement, a business organization will be able to retain for every pre-tax sodor earned. From these after-tax profits, it will then pay any owed on its borrowed capital and any to its shareholders. Given these provisions, the current system the use of one form of financing (debt versus equity) over the other. This is because the arrangement allows for the tax deductibility of financing. The sheaf of papers accompanying the journal describes several potential revisions to the Rodosian personal and business tax code, including replacing the existing system with a progressive tax system, the assessment of different luxury and sin taxes, and/or modifications of the provisions of the current system. Two of the specific proposals include the following: Policy Proposal 1: Replace the existing system with a progressive tax system that would tax business and individuals, using these schedules: Business Tax Rates If your Taxable Income Is You Pay This Amount on the Base of the Bracket Plus This Percentage on the Excess over the Base SRO 12% SR960,000 18% 24% SR2,220,000 Up to SR8,000,000 SR8,000,000-SR15,000,000 SR15,000,000- SR31,000,000 SR31,000,000- SR47,000,000 SROver 47,000,000 Personal Tax Rates SR6,060,000 30% SR10,860,000 36% If your Taxable income is You Pay This Amount on the Base of the Bracket Plus This Percentage on the Excess over the Base Up to SR8,000 SRO 6% SR480 10% SR8,000-SR28,000 SR28,000-SR62,000 SROver 62,000 16% SR2,480 SR7,920 25% Given these tax schedules, calculate the tax liabilities for: Vinber Vintners Company, which earns an income of SR35,000,000 The following three individual taxpayers: (1) Baldur, a beekeeper earning SR24,000 per year; (2) Lara, a cooper (barrel maker) Vinber Vintners Company, which earns an income of SR35,000,000 The following three individual taxpayers: (1) Baldur, a beekeeper earning SR24,000 per year; (2) Lara, a cooper (barrel maker) earning SR54,000 per year; (3) Hinrik, banker earning SR96,000 per year Note: Round your average tax rate answers to two decimal places. Taxpayer Average Tax Rate Tax Obligation SR Vinber Vintners % Baldur SR % Lara % SR SR Hinrik % If you were the owner or manager of a Rodosian business, such as Vinber Vintners, would you prefer the existing tax system or the progressive tax system? Why? The progressive tax system, because the firm's tax obligation would be greater than that incurred under the existing system. This would reduce the profit available to the firm and its shareholders. The existing tax system, because my tax obligation would be greater than that incurred under the progressive system. This would reduce the profit available to the firm and its shareholders. The existing tax system, because my tax obligation would be less than that incurred under the progressive system. This would increase the amount of funds available to the firm's shareholders. Policy Proposal 2: Assess a special tax on businesses that own more than 10 horses or oxen. What effect will this tax have on Rodosian businesses? The tax will not affect the businesses being assessed the tax or the Treasury's tax revenues. This is an example of a sin tax. This tax on more than 10 horses or oxen has the potential to penalize businesses from growing beyond a certain level. This will reduce the Treasury's tax revenues and potentially limit the growth potential and sales of businesses that provide goods and services to the taxpayers being assessed