[Anonymous]

This problem is getting the best of me. Maybe I’ve been studying for too long… Where/how is the 34,000 calculated in the “Annual Cash Savings” in the provided solution?

Thanks for your help:

MCQ Question # 273

McLean, Inc., is considering the purchase of a new machine that will cost $150,000. The machine has an estimated useful life of three years. Assume for simplicity that the equipment will be fully depreciated 30, 40, and 30% in each of the three years, respectively. The new machine will have a $10,000 resale value at the end of its estimated useful life. The machine is expected to save the company $85,000 per year in operating expenses. McLean uses a 40% estimated income tax rate and a 16% hurdle rate to evaluate capital projects.

Discount rates for a 16% rate are as follows.

Present Value of an

Present Value of $1 Ordinary Annuity of $1

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Year 1 0.8621 0.8621

Year 2 0.7432 1.6052

Year 3 0.6407 2.2459

What is the net present value of this project?

A.

$15,842

B.

$13,278

C.

$9,432

D.

$(35,454)

To determine the net present value of this project, set up an analysis of cash flows as follows:

Annual Annual Annual Annual

Before Tax Tax Aftertax Aftertax

Cash Flows Savings Cash Flow Net Income

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Investment Year 0 (150,000) 0 (150,000) 0

Annual cash savings Year 1-3 85,000 (34,000) 51,000 51,000

Depreciation effect Year 1 18,000 18,000 (27,000)*

Year 2 24,000 24,000 (36,000)**

Year 3 18,000 18,000 (27,000)*

Gain on Disposal Year 3 10,000 (4,000) 6,000 6,000

These depreciation effects are calculated as follows:

Yr1 150,000 x .30 (depreciation) x .40 (tax rate) = 18,000

Yr2 150,000 x .40 (depreciation) x .40 (tax rate) = 24,000

Yr3 150,000 x .30 (depreciation) x .40 (tax rate) = 18,000

* 18,000 – (150,000 x .30 depreciation) = (27,000)

** 24,000 – (150,000 x .40 depreciation) = (36,000)

Now determine the Net Present Value of Annual Aftertax Cash Flow by year.

Annual Present Net

Aftertax Value Present

Cash Flow x of $1 = Value

Yrly Total: Yr 0 (150,000) x 1.0000 = (150,000)

Yr 1 (51,000 + 18,000) x 0.8621 = 59,485

Yr 2 (51,000 + 24,000) x 0.7432 = 55,740

Yr 3 (51,000 + 18,000 + 6,000) x 0.6407 = 48,053

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Total 13,278

[jgmart04]

Bumping this. Any help??

[Anonymous]

$34k is the tax

[kkloefkorn]

34,000 is the 85,000 annual cash savings multiplied by the estimated income tax rate of 40%

[Author]

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