396 INCOME TAXES
'I
Ann Arbor Municipal Bonds:A bond with a face
value of $1000 pays $60 per annum. At the end
of 15 years, the bond becomes due ("matures"),
at which time the owner of the bond will receive
$1000 plus the final $60 annual payment. The
bond may be purchased for $800. Since it is a
municipal bond, the annual interest isnotsubject
to federal income tax. The difference between
what the businessman would pay for the bond
($800) and the $1000 face value he would re-
ceive at the end of 15 years must be included in
taxable income when the$1000is received.
Southern Coal Corporation Bonds:A thousand-
dollar bond yields $100 per year in annual inter-
est payments. When the bonds mature at the end
of 20 years, the bondholder will receive $1000
plus the final $100 interest. The bonds may be
purchased now for $1000. The income from cor-
poration bonds must be included in federal tax-
able income.
12-52 A small-business corporation is considering whether
to replace some equipment in the plant. An analy-
sis indicates there are five alternatives in addition to
the do-nothing option, Alt.A.The alternatives have a
5-year useful life with no salvage value. Straight-line
depreciation would be used.
Alternatives
A B C D E F
Cost
(thousands)
$ 0
25
10
5
15
30
Before-Tax Uniform
Annual Benefits
(thousands)
$0
7.5
3
1.7
5
8.7
The corporation has a combined federal and state in-
come tax rate of 20%. If the corporation expects a
10% after-tax rate of return for any new investments,
which alternative should be selected?
12-53 A corporation with $7 million in annual taxable
income is considering two alternatives:
Before-TaxCash Flow
Year Alt. 1 Alt. 2
o
1-10
11-20
-$10,000
4,500
o
-$20;000
4,500
4,500
Both alternatives will be depreciated by straight-line
depreciation assuming a lO-year depreciable life and
no salvage value. Neither alternative is to be replaced
at the end of its useful life. If the corporation has a
minimum attractive rate of return of 10%after taxes,
which alternative should it choose? Solve the problem
by:
(a)Present worth analysis
(b) Annual cash flow analysis
(c) Rate of return analysis
(d) Future worth analysis
(e) Benefit-cost ratio analysis
(f) Any other method you choose
12-54 Two mutually exclusive alternatives are being Con'-
sidered by a profitable corporation with an annual
taxable income between $5 million and $10 million.
Both alternatives have a 5-yearuseful and depreciable
life and no salvage value. AlternativeAwould be de-
preciated by sum-of-years' -digits depre,ciation, and
Alt.Bby straight-line depreciation. If the MARR is
10% after taxes, 'Yhich alternative should"be selected?
(Answer:Alt.B)
12-55 A large profitable corporation is considering two
mutually exclusive capital investments:
Alt.A
$11,000
3,000
2,000
Alt.B
$33,000
9,000
3,000
Initial cost
Uniform annual benefit
End-of-depreciable-life
salvage value
Depreciation method
End-of -useful-life
salvage value obtained
Depreciable life, in years 3 4
Useful life, in years 5 5
J
~
If the firm's after-tax minimum attractive rate of re-
turn is 12% and its incremental income tax rate is ....
34%, which project should be selected?~,
SL
2,000
SOYD
5,000
Before-TaxCash Flow
Year Alt.A Alt.B
0 -$3000 -$5000
1 1000 1000
2 1000 1200
3 1000 1400
4 1000 2600
5 1000 2800