Problems 39312-34 A profitable wood products corporation is consid-
ering buying a parcel of land for $50,000, building
a small factory building at a cost of $200,000, and
equipping it with $150,000 of MACRS 5-year class
machinery.
If the project is undertaken, MACRS deprecia-
tion will be used. Assume the plant is put in service
October 1. The before-tax net annual benefit from the
project is estimated at $70,000 per year. The analysis
period is to be 5 years, and planners assume the sale
of the total property (land, building, and machinery)
at the end of 5 years, also on October 1, for $328,000.
Compute the after-tax cash flow based on a 34% in-
come tax rate. If the corporation's criterion is a 15%
after-tax rate of return, should it proceed- with the
project?
12-35 A small vessel was purchased by a chemical company
for $55,000 and is to be depreciated by MACRS de-
preciation. When its requirements changed suddenly,
the chemical company leased the vessel to an oil com-
pany for 6 years at $10,000 per year. The lease also
provided that the vessel could be purchased at the end
of 6 years by the oil company for $35,000. At the end
of the 6 years, the oil company exercised its option
and bought the vessel. The chemical company has a
34% incremental tax rate. Compute its after-tax rate
of return on the vessel. (Answer: 9.86%)
12-36 Xon, a small oil company, purchased a new petroleum
drilling rig for $1,800,000. Xon will depreciate the
drilling rig using MACRS depreciation. The drilling
rig has been leased to a drilling company, which will
pay Xon $450,000 per year for 8 years. At the end
of 8 years the drilling rig will belong to the drilling
company. If Xon has a 34% incremental tax rate and
a 10% after-tax MARR, does the investment appear
to be satisfactory?12-37 The profitable Palmer Golf Cart Corp. is considering
investing $300,000 in special tools for some of the
plastic golf cart components. Executives of the com-
pany believe the present golf cart model will continue
to be manufactured and sold for 5 years, after which
a new cart design will be needed, together with a dif-
ferent set of special tools.
The saving in manufacturing costs, owing to the
special tools, is estimated to be $150,000 per year for
5 years. Assume MACRS depreciation for the special
tools and a 39% income tax rate.
(a)What is the after-tax payback period for this
investment?
(b)If the company wants a 12% after-tax rate ofre-
turn, is this a desirable investment?
12-38 Uncle Elmo is contemplating a $10,000 investment
in a methane gas generator. He estimates his gross
income would be $2000 the first year and increase by
$200 each year over the next 10 years. His expenses of
$200 the first year would increase by $200 each year
over the next 10 years. He would depreciate the gen-
erator by MACRS depreciation, assuming a 7-year
property class. A lO-year-old methane generator has
no market value. The income tax rate is 40%. (Re-
member that recaptured depreciation is taxed at the
same 40% rate).
(a) Construct the after-tax cash flow for the 10 year
project life.
(b) Determine the after-tax rate ofreturn on this in-
vestment. Uncle Elmo thinks it should be at least
8%.
(c) If Uncle Elmo could sell the generator for $7000
at the end of the fifth year, would his rate of return
be better than if he kept the generator for 10 years?
You don't have to actually find the rate of return,
Just do enough calculations to see whether it is
higher than that of part(b).
12-39 Granny's Butter and Egg Business is such that she
pays an effective tax rate of 40%. Granny is consider-
ing the purchase of a new Thrbo Churn for $25,000.
This churn is a special handling device for food man-
ufacture and has an estimated life of 4 years and a
salvage value of $5000. The new churn is expected
to increase net income by $8000 per year for each
of the 4 years of use. If Granny works with an after-
tax MARR of 10% and uses MACRS depreciation,
should she buy the churn? -
12-40 Eric Heiden has a house aDd lot for sale for $70,000.
It is estimated that $10,000 is the value of the land
and $60,000 is the value of the house. Bonnie Blair is
purchasing the house on January 1 to rent and plans
to own the house for 5 years. After 5 years, it is ex-
pected that the house and land can be sold on Decem-
ber 31 for $80,000. Total annual expenses (mainte-
nance, property taxes, insurance, etc.) are expected to
be $3000 per year. The house would be depreciated
by MACRS depreciation using a 27.5-year straight-
line rate with midmonth convention for rental prop-
erty. For depreciation, a salvage value of zero was
used. Bonnie wants a 15% after-tax rate of return Oij
her investment. You may assume that Bonnie has an
incremental income tax rate of 27% in eachofthe"