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Chapter 3 P1: Stephen Company is evaluating a capital investment proposal for new office equipment for the...

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Accounting

Chapter 3 P1:

Stephen Company is evaluating a capital investment proposal fornew office equipment for the current year. The initial investmentwould require the company to spend $50,000. The equipment would bedepreciated on a straight line basis over five years with nosalvage value. The company has estimated the before-tax annual cashinflow from the investment to be $15,000. The income tax rate is40% and all taxes are paid in the year that the related cash flowsoccur. All cash flows occur at year end.

Determine the NPV of the capital investment proposal at 15%, thedesired after-tax rate of return. Should the proposal be acceptedor not accepted? Explain.

Answer & Explanation Solved by verified expert
3.6 Ratings (254 Votes)

Depreciation = [cost-salvage value ]/useful life

                  = [50000-0]/5

                  = $ 10000

Income before tax = before tax annual cash inflow - depreciation

                 = 15000 - 10000

                 = 5000

Income after tax = 5000[1-.40] = 3000

Annual cash flow (after tax ) = Income after tax +depreciation

                              = 3000+ 10000

                               = 13000

Present value of annual cash flow =PVA 15%,5* Annual cash flow (after tax)

                  = 3.35216* 13000

                = $ 43578.08

NPV = Present value- Initial investment

       = 43578.08 - 50000

     = - 6421.92

since NPV is negative ,proposal should not be accepted.
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Transcribed Image Text

Chapter 3 P1:Stephen Company is evaluating a capital investment proposal fornew office equipment for the current year. The initial investmentwould require the company to spend $50,000. The equipment would bedepreciated on a straight line basis over five years with nosalvage value. The company has estimated the before-tax annual cashinflow from the investment to be $15,000. The income tax rate is40% and all taxes are paid in the year that the related cash flowsoccur. All cash flows occur at year end.Determine the NPV of the capital investment proposal at 15%, thedesired after-tax rate of return. Should the proposal be acceptedor not accepted? Explain.

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