390 INCOME TAXES
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new assets is under consideration. It is estimated that
for the next 8 years, these assets will be responsi-
ble for annual receipts of $9000 and annual disburse-
ments (other than for income taxes) of $4000. Mter
this time, they will be used only for stand-by purposes,
and no future excess of receipts over disbursements
is estimated.
(a) What is the prospective rate ofretum before in-
come taxes?
(b) What is the prospective rate of return after taxes
if straight-line depreciation can be used to write
off these assets for tax purposes in 8 years?
(c) What is the prospective rate of return after taxes
if it is assumed that these assets must be written
off for tax purposes over the next 20 years, using
straight-line depreciation?
12-18 A firm is considering the following investment
project:
Year
o 1 2 3 4 5
Before-Tax
Cash Flow
(thousands)
-$1000
+500
+340
+244
+100
{
+100
+ 125 Salvage value}
The project has a 5-year useful life with a $125,000
salvage value, as shown. Double declining balance
depreciation will be used, assuming the $125,000
,salvage value. The income, tax rate is 34%. If the
firm requires a 10% after-tax rate of return, should
the project be undertaken?
12-19 The Shellout Corp. owns a piece of petroleum drilling
equipment that costs $100,000 and will be depreci-
ated in 10 years by double declining balance depre-
ciation, with conversion to straight-line depreciation
at the optimal point. Assume no salvage value in the
depreciation computation and a 34% tax rate. Shell-
out will lease the equipment to others and each year
receive $30,000 in rent. At the end of 5 years, the
firm will sell the equipment for $35,000. (Note that
this is different from the zero-salvage-value assump-
tion used in computing the depreciation.) What is the
after-tax rate of return Shellout will receive from this
equipment investment?
12-20 A mining corporation purchased $120,000 of produc-
tion machinery and depreciated it using SOYD de-
preciation, a 5-year depreciable life, and zero salvage
value. The corporation is a profitable one that has a
34% incremental tax rate.
At the end of 5 years the mining company
changed its method of operation and sold the pro-
duction machinery for $40,000. During the 5' years
the machinery was used, it reduced mine operating
costs by $32,000 a year, before taxes. If the company
MARR is 12% after taxes, was the investment in the
machinery a satisfactory one?
12-21 An automobile manufacturer is buying some special
tools for $100,000. The tools are being'depreciated'
by double declining balance depreciation using a 4-
year depreciable life and a $6250 salvage value. It
is expected the tools will actually be kept in service
for 6 years and then sold for $6250. The before-tax
benefit of owning the tools is as follows:
Before-Tax
Cash Flow'
$30,000
30,000
35,000
40,000
10,000
10,000
6,250 Selling price
Compute the after-tax rate of return for this invest-
ment situation, assuming a 46% incremental tax rate.
(Answer:11.6%)
12-22 This is the continuation of Problem 12-21. Instead
of paying $100,000 cash for the tools, the corpora-
tion will pay $20,000 ~ow and borrow the remaining
$80,000. The depreciation schedule will remain un-
changed. The loan will be repaid by 4 equal end-of-
year payments of $25,240.
Prepare an expanded cash flow table that takes
into account both the special tools and the loan.
Estimating the After-Tax Rate of Return- -
taking into account the $80,000 loan.
(b)Explain why the rate of return obtained in part
(a)is different from the rate of return obtained in
Problem 12-21.
Hints:1. Interest on the loan is 10%, $25,240 =
80,000 (AlP, 10%,4). Each payment is
made up of part interest and part principal.
Interest portion for any year is 10% of bal-
ance due at the beginning of the year.
Year
1
2
3
4
5'
6