Engineering Economic Analysis

394 INCOME TAXES

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5 years. Capital gains are taxed at 20%. Detennine

the following:

(a)The annual depreciation.

(b) The capital gain (loss) resulting from the sale of

the house.

(c) The annual rent Bonnie must charge to produce

an after-tax rate of return of 15%.(Hint:Write an

algebraic equation to solve for rent.)

12-41 Bill Cavitt owns a data processing company. He plans

to buy an additional computer for $20,000, use the

computer for 3 years, and sell it for $10,000. He ex-

pects that use of the computer will produce a net in-

come of $8000 per year. The combined federal and

state incremental tax rate is 45%. Using MACRS de-

preciation, complete Table P12-41 to detennine the

net present worth of the after tax cash flow using an

Selecting an Interest Rate

12-42 Refer to Problem 12-33. To help pay for the pickup

truck the Ogi Corp. obtained a $10,000 loan from the

truck dealer, payable in four end-of-year payments

of $2500 plus 10% interest on the loan balance each

year.

(a) Compute the after-tax rate of return for the truck

together with the loan. Note that the interest on

the loan is tax deductible, but the $2500 principal

payments are not.

(b) Why is the after-tax rate of return computed in

part(a) so much different from the 12.5% ob-

tained in Problem 12-33?

12-43 A store owner, Joe Lang, believes his business has
suffered from the lack of adequate customer park-
ing space. Thus, when he was offered an opportu-
nity to buy an old building and lot next to his store,
he was interested. He would demolish the old build-
ing and make off-street parking for 20 customers'

cars. Joe estimates that the new parking would in-

crease his business and produce an additional before-

income-tax profit of $7000 per year. It would cost

$2500 to demolish the old building. Mr. Lang's ac-

countant advised that both costs (the property and

demolishing the old building) would be considered

to comprise the total value of the land for tax pur-

poses, and it would not be depreciable. Mr. Lang

would spend an additional $3000 right away to put

a light gravel surface on the lot. This expenditure,

he believes, may be charged as an operating expense

immediately and need not be capitalized. To compute

the tax consequences of adding the parking lot, Joe

estimates that his combined state and federal incre.-

mental income tax rate will average 40%. If Joe wants

a 15% after-tax rate of return from this project, how

much could he pay to purchase the adjoining land

with the old building? Assume that the analysis pe-

riod is 10 years and that the parking lot could always

be sold to recover the costs of buying the property and

demolishing the old building. (Answer: $23,100)

12-44 The management of a private hospital is consider-

ing the installation of an automatic telephone switch-

board, which would replace a manual switchboard

and eliminate the attendant operator's position. The

class of service provided by the new equipment is es-

timated to be at least equal to the present method of

operation. To provide telephone service, five opera-

tors will work three shifts per day, 365 days per year.

Each operator earns $14,000 per year. Company-paid

benefits and overhead are 25% of wages. Money co'sts

8% after income taxes. Combined federal and state in-

come taxes are 40%. Annual property taxes and main-

tenance are 21;2 and 4% of investment, respectively.

Depreciation is I5-year straight line. Disregarding

--

After-Tax Present

Year I Cash Flow Depreciation Tax (45%) Cash Flow Worth (12%)

(^0) -$20,000
(^1) +8,000
(^2) +8,000
(^3) +8,000

-

• 10,000

I I

Net Present worth=