Problems 471Assume Sam's incremental income tax rate re-
mains at 34:.%for all ordinary taxable income
related to the property. The value of the prop-
erty is now projected to increase from its present
$85,000 at a rate of 10% per year, compounded
annually.
If the property is sold at the end of 5 years,
compute the rate of return on the after-tax cash
flow in actual dollars. Also compute the rate of
return on the after-tax cash flow in year-O dollars.
14-50 Tom Ward put $10,000 in a 5-year certificate of
deposit that pays 12% interest per year. At the end
of the 5 years the certificate will mature and he will
receive his $10,000 back. Tom has substantial income
from other sources and estimates that his incremental
income tax rate is 42%. If the inflation rate is 7% per
year, find his
(a) before-tax rate of return, ignoring inflation
(b) after-tax rate of return, ignoring inflation
(c) after-tax rate of return, after taking inflation into
account
14-51 Dick DeWolf and his wife have a total taxable income
of $60,000 this year and file a joint federal income
tax return. If inflation continues for the next 20 years
at a 7% rate, compounded annually, Dick wonders
what their taxable income must be in the future to
provide them the same purchasing power, after taxes,
as their present taxable income. Assuming the federal
income tax rate table is unchanged, what must their
taxable income be 20 years from now?
14-52 A small research device is purchased for $10,000 and
depreciated by MACRS depreciation. The net bene-
fits from the device, before deducting depreciation,
a,re $2000 at the end of the first year and increasing
$1000 per year after that (second year equals $3000,
third year equals $4000, etc.), until the device is
hauled to the junkyard at the end of 7 years. During
the 7-year period there is an inflation ratef of 7%.
This profitable corporation has a 50% combined
federal and state income tax rate. If it requires a 12%
after-tax rate of return on its investment, after taking
inflation into account, should the device have been
purchased?14-53 When there is little or no inflation, a homeowner can
expect to rent an unfurnished home for 12% of the
market value of the property (home and land) per year.
About 18 of the rental income is paid out for prop-
erty taxes, insurance, and other operating expenses.
Thus the net annual income to the owner is 10.5%
of the market value of the property. Since prices are
relatively stable, the future selling price of the prop-
erty often equals the original price paid by the owner.
For a $150,000 property (where the land is
estimated at $46,500 of the $150,000), compute the
after-tax rate of return, assuming the selling price
59 months later (in December) equals the original pur-,
chase price. Use modified accelerated cost recovery
system depreciation beginning January 1. Also,
assume a 35% income tax rate. (Answer: 6.84%)
14-54 (This is a continuation of Problem 14-53.) As inflation
has increased throughout the world, the rental income
of homes has decreased and a net annual rental income
of 8% of the market value of the property is common.
On the other hand, the market value of homes tends
to rise about 2% per year more than the inflation
rate. As a result, both annual net rental income, and
the resale value of the property rise faster than the
inflation rate. Consider the following situation.
A $150,000 property (with the house valued at
$103,500 and the land at $46,500) is purchased for
cash in Year O. The market value of the property
increases at a 12% annual rate. The annual rental
income is 8% of the beginning-of-year market value
of the property. Thus the rental income also increases
each year. The general inflation ratef is 10%.
The individual who purchased the property has
an average income tax rate of 35%.
(a) Use MACRS depreciation, beginning January
1, to compute the actual dollar after-tax rate of
return for the owner, assuming he sells the prop-
erty 59 months later (in December).
(b) Similarly, compute the after-tax rate of return for
the owner, after taking the general inflation rate
into account, assuming he sells the property 59
months later.
14-55 Consider two mutually exclusive alternatives stated
in year-O dollars. Both alternatives have a 3-year life
with no salvage value. Assume the annual inflation
rate is 5%, an income tax rate of 25%, and straight
line depreciation. The minimum attractive rate of
return (MARR) is 7%. Use rate ofreturn analysis to
determine which alternative is preferable.Year A B I(^0) -$420 -$300
1 200 150
2 200 150
3 200 150