Chapter 13

Income Taxes
13-1
A tool costing $300 has no salvage value and will be depreciated over 3 years according to the
sum-of-the-years-digits method. The cash flows before tax due to the tool are shown below. The
tax rate is 35%.

SOYD Taxable
Year BTCF Depreciation Income Taxes ATCF
0 -$300
1 +100
2 +150
3 +200

a) Fill in the table.

b) What is the internal rate of return after tax?

Solution

a)
SOYD Taxable
Year BTCF Depreciation Income Taxes ATCF
0 -$300 - - - -300.00
1 +100 150 -50 -17.50 +117.50
2 +150 100 +50 +17.50 +132.50
3 +200 50 +150 +52.50 +147.50

b) NPW = -300 + 117.50(P/A, i%, 3) + 15(P/G, i%, 3) = 0

By trial and error.

Try i = 12% NPW = $15.55

Try i = 15% NPW = -$ 0.68

IRR = i 15% (By interpolation i = 14.87%)

13-2

181
182 Chapter 13 Income Taxes
A company, whose earnings put them in the 35% marginal tax bracket, is considering the purchase
of a new piece of equipment for $25,000. The equipment will be depreciated using the straight
line method over a 4-year depreciable life to a salvage value of $5,000. It is estimated that the
equipment will increase the companys earnings by $8,000 for each of the 4 years it is used.
Should the equipment be purchased? Use an interest rate of 10%.

Solution

Year BTCF Depreciation T.I Taxes ATCF

0 -25,000 -25,000
1 8,000 5,000 3,000 1,050 6,950
2 8,000 5,000 3,000 1,050 6,950
3 8,000 5,000 3,000 1,050 6,950
4 8,000 5,000 3,000 1,050 6,950
5,000 5,000

SL Depreciation = (25,000 - 5,000) = $5,000

Find net present worth: if NPV > 0 purchase equipment.

NPV = -25,000 + 6,950(P/A, 10%, 4) + 5,000(P/F, 10%, 4) = $446.50

Purchase equipment

13-3
By purchasing a truck for $30,000, a large profitable company in the 34% income tax bracket was
able to save $8,000 during year 1, with the savings decreasing by $1,000 each year thereafter. The
company depreciated the truck using the sum-of-years-digits depreciation method over its four
year depreciable life, while assuming a zero salvage value for depreciation purpose. The company
wants to sell the truck at the end of year 5. What resale value will yield a 12% after-tax rate of
return for the company?

Solution

SOYD = = 10
Year Depreciation
1 4/10(30,000 - 0) = 12,000
2 3/10(30,000 - 0) = 9,000
3 2/10(30,000 - 0) = 6,000
4 1/10(30,000 - 0) = 3,000

ATCF Calculations:

Year BTCF Depreciation T.I. Taxes ATCF

0 -30,000 - - - -30,000
 Chapter 13 Income Taxes 183
1 8,000 12,000 -4,000 -1,360 9,360
2 7,000 9,000 -2,000 -680 7,680
3 6,000 6,000 -0,000 0 6,000
4 5,000 3,000 2,000 +680 4,320
5 4,000 - 4,000 +1,360 2,640
Resale - Resale .34Resale .66Resale

Solve for Resale (R):

30,000 = 9,360(P/A, 12%, 5) - 1,680(P/G, 12%, 5) + .66R(P/F, 12%, 5)
30,000 = 22,995.84 + .374484R
R = $18,703.50

13-4
A company has purchased a major piece of equipment that has a useful life of 20 years. An
analyst is trying to decide on a maintenance program and has narrowed the choice to two
alternatives. Alternative A is to perform $1,000 of major maintenance every year. Alternative B
is to perform $,5000 of major maintenance only every fourth year. In either case, maintenance
will be performed during the last year so that the equipment can be sold for $10,000. If the
MARR is 18%, which maintenance plan should be chosen? Is it possible the decision would
change if income taxes were considered? Why or Why not?

Solution

Equivalent Annual CostA = $1,000

Equivalent Annual CostB = $5,000(A/F, 18%, 4) = $958.50
Therefore choose Alternative B.

The decision would not change it taxes were considered. The cash flows for both alternatives,
would be reduced by the same percentage due to taxes so EACA > EACB would still be true.
If we assume a 45% tax rate, for example, the computations as follows:

Alternative A Year BTCF T.I. Taxes ATCF

1-4 -1,000 -1,000 -450 -550
EACA = $550
Alternative B Year BTCF T.I. Taxes ATCF
1-3 0 0 0 0
4 -5,000 -5,000 -2,250 -2,750
EACB = 2,750(A/F, 18%, 4) = $527.20

13-5
A large company must build a bridge to have access to land for expansion of its manufacturing
plant. The bridge could be fabricated of normal steel for an initial cost of $30,000 and should last
15 years. Maintenance will cost $1,000/year. If more corrosion resistant steel were used, the
annual maintenance cost would be only $100/year, although the life would be the same. In 15
years there will be no salvage value for either bridge. The company pays a combined state and
federal income tax rate of 48% and uses straight-line depreciation. If the minimum attractive after
184 Chapter 13 Income Taxes
tax rate of return is 12%, what is the maximum amount that should be spent on the corrosion
resistant bridge?

Solution

Steel

Year BTCF Depreciation T.I. Taxes ATCF

0 -30,000 -30,000
1-15 -1,000 2,000 -3,000 -1,440 +440

Corrosion Resistant Steel

Year BTCF Depreciation T.I. Taxes ATCF

0 -P -P
1-15 -100 P/15 -100 - P/15 (-48 - .032P) -52 + .032P

NPWA = NPWB for breakeven

440(P/A, 12%, 15) - 30,000 = (-52 + .032P)(P/A, 12%, 15) - P

-27,003 = -354 + .0281P - P
P = $34,078

13-6
Gillespie Gold Products Inc. is considering the purchase of new smelting equipment. The
new equipment is expected to increase production and decrease costs with a resulting increase
in profits. The equipment under consideration is summarized below. Determine the after-tax
cash flow using a tax rate of 42% and sum-of-the-years-digits depreciation.

Cost $50,000
Net Savings/year 15,000 the first year decreasing by $1,000 each year thereafter
Depreciable Life 4 yrs
Actual Useful Life 6 yrs
Salvage Value 4,000

Solution

Year BTCF Depreciation TI Taxes ATCF

0 -50,000 - - - -50,000
1 15,000 18,400 -3,400 -1,428 16,428
2 14,000 13,800 200 84 13,916
3 13,000 9,200 3,800 1,596 11,404
4 12,000 4,600 7,400 3,108 8,892
5 11,000 - 11,000 4,620 6,380
 Chapter 13 Income Taxes 185
6 14,000 - 10,000 4,200 9,800

$4,000 capital recovery in year 6 is not taxable.

13-7
An asset with five year MACRS* life will be purchased for $10,000. It will produce net annual
benefits of $2,000 per year for six years, after which it will have a net salvage value of zero and
will be retired. The companys incremental tax is 34%. Calculate the after tax cash flows.

*The MACRS annual percentages are 20, 32, 19.20, 11.52, 11.52, and 5.76 for years 1 through 6.

Solution
Year BTCF Depreciation T.I. Taxes ATCF
0 -10,000 -10,000.00
1 2,000 2,000 0 0 2,000.00
2 2,000 3,200 -1,200 -408.00 2,408.00
3 2,000 1,920 80 +27.20 1,972.80
4 2,000 1,152 848 +288.32 1,711.68
5 2,000 1,152 848 +288.32 1,711.68
6 2,000 576 1,424 +484.16 1,515.84

13-8
A state tax of 10% is deductible from the income taxed by the federal government. The federal
tax is 34%. The combined effective tax rate is

a. 24.0%
b. 35.0%
c. 40.6%
d. 45.0%

Solution

Effective rate = S + (1 - S)F

= .1 + (1 - .1).34
= .1 + (.9).34
= .1 + .306
= .406 = 40.6%

The answer is c.

13-9
For engineering economic analysis a corporation uses an incremental state income tax rate of 7.4%
and an incremental federal rate of 34%. Calculate the effective tax rate.
186 Chapter 13 Income Taxes
Solution

Effective rate = S + (1 - S)F

= .074 + (1 - .074)(.34)
= .074 + (.926).34
= .074 + .3148
= .3888 = 38.88%

13-10
A one-year savings certificate that pays 15% is purchased for $10,000. If the purchaser pays taxes
at the 27% incremental income tax rate, the after tax rate of return on this investment is

a. 4.05%
b. 10.95%
c. 15.00%
d. 22.95%

Solution

After tax ROR = (1 - tax rate)(before tax IRR) = (1 - .27)(.15) = 10.95%

The answer is b.

13-11
A corporations tax rate is 34%. An outlay of $35,000 is being considered for a new asset.
Estimated annual receipts are $20,000 and annual disbursements $10,000. The useful life of the
asset is 5 years and it has no salvage value.

a) What is the prospective rate of return before income tax?

b) What is the prospective rate of return after taxes, assuming straight-line depreciation?

Solution

StL Depreciation = (P S) = = $7,000/year.

Year BTCF Depreciation T.I. Taxes ATCF

0 -35,000 - - - -35,000
1 10,000 7,000 3,000 1,020 8,980
2 10,000 7,000 3,000 1,020 8,980
3 10,000 7,000 3,000 1,020 8,980
4 10,000 7,000 3,000 1,020 8,980
5 10,000 7,000 3,000 1,020 8,980

a) RORBEFORE TAX

PWB = PWC
10,000(P/A, i%, 5) = 35,000 At 12% P/A = 3.605
 Chapter 13 Income Taxes 187
(P/A, i%, 5) = = 3.5 00 At i% P/A = 3.500
At 15% P/A = 3.352
By interpolation:
ROR = 13.25%

b) RORAFTER TAX

PWB = PWC
8,980(P/A, i%, n) = 35,000 At 8% P/A = 3.993
(P/A, i%, 5) = = 3.898 At i% P/A = 3.898
At 9% P/A = 3.890
By interpolation:
ROR = 8.92%

13-12
A large and profitable company, in the 34% income tax bracket, is considering the purchase of a
new piece of machinery that will yield benefits of $10,000 for year 1, $15,000 for year 2, $20,000
for year 3, $20,000 for year 4, and $20,000 for year 5. The machinery is to be depreciated using
the modified accelerated cost recovery system (MACRS) with a three-year recovery period. The
MACRS percentages are 33.33, 44.45, 14.81, 8.41, respectively, for years 1, 2, 3, and 4. The
company believes the machinery can be sold at the end of five years of use for 25% of the original
purchase price. What is the maximum purchase cost the company can pay if it requires a 12%
after-tax rate of return?

Solution

Year BTCF Depreciation T.I. Taxes ATCF

0 -P - - - -P
1 10,000 .3333P 10,000 - .3333P 3,400 + .1133P 6,600 + .1133P
2 15,000 .4445P 15,000 - .4445P 5,100 + .1511P 9,900 + .1511P
3 20,000 .1481P 20,000 - .1481P 6,800 + .0504P 13,200 + .0504P
4 20,000 .0841P 20,000 - .0841P 6,800 + .0286P 13,200 + .0286P
5 20,000 - 20,000 6,800 13,200
.25P - .25P .085P .165P

P = 6,600(P/A 12%, 3) + 3,300(P/G, 12%, 3) + 13,200(P/A, 12%, 2)(P/F, 12%, 3)

+ .1133P(P/F, 12%, 1) + .1511P(P/F, 12%, 2) + .0504P(P/F, 12%, 3)
+ .0285P(P/F, 12%, 4) + .165P(P/F, 12%, 5)
P = $61,926.52

13-13
A company bought an asset at the beginning of 2007 for $100,000. The company now has an
offer to sell the asset for $60,000 at the end of 2008. For each of the depreciation methods shown
below determine the capital loss or recaptured depreciation that would be realized for 2008.
Depreciation Depreciable Salvage Recaptured Capital
188 Chapter 13 Income Taxes
Method Life Value* Depreciation Loss
SL 10 years $ 1,000
SOYD 5 25,000
DDB 4 0
150%DB 15 0

*This was assumed for depreciation purposes

Solution
Depreciation Depreciable Salvage Recaptured Capital
Method Life Value* Depreciation Loss
SL 10 years $ 1,000 $20,200
SOYD 5 25,000 $ 5,000
DDB 4 0 35,000
150%DB 15 0 21,000

SL
Depreciation = (100,000 - 1,000) = 9,900

Book Value = 100,000 - 2(9,900) = 80,200

Capital Loss = 80,200 - 60,000 = $20,200

SOYD
Depreciation (Year 1 + Year 2) = (100,000 - 25,000) = 45,000

Book Value = 100,000 - 45,000 = 55,000

Recaptured Depreciation = 60,000 - 55,000 = $5,000

DDB
Depreciation Year 1 = (100,000) = 50,000

Depreciation Year 2 = (100,000 - 50,000) = 25,000

Book Value = 100,000 - 75,000 = 25,000

Recaptured Depreciation = 60,000 - 25,000 = $35,000

150%DB
Depreciation Year 1 = (100,000) = 10,000

Depreciation Year 2 = (100,000 - 10,000) = 9,000

Book Value = 100,000 - 19,000 = 81,000

Capital Loss = 81,000 - 60,000 = $35,000
 Chapter 13 Income Taxes 189

13-14
A corporation expects to receive $32,000 each year for 15 years if a particular project is
undertaken. There will be an initial investment of $150,000. The expenses associated with the
project are expected to be $7,530 per year. Assume straight-line depreciation, a 15-year useful life
and no salvage value. Use a combined state and federal 48% income tax rate and determine the
projects after-tax rate of return.

Solution

Year BTCF Depreciation T.I. Taxes ATCF

0 -150,000 -150,000
1-30 24,470 10,000 14,470 6,946 17,524

Take the ATCF and compute the interest rate where the PWBENEFITS equals PWCOSTS.

17,524(P/A, i%, 15) = 150,000

(P/A, i%, 15) = = 8.559

From interest tables, i = 8%

13-15
A manufacturing firm purchases a machine in January for $100,000. The machine has an
estimated useful life of 5 years, with an estimated salvage value of $20,000. The use of the
machine should generate $40,000 before-tax profit each year over its 5-year useful life. The firm
pays combined taxes at the 40% and uses sum-of-the-years-digits depreciation.

PART 1 Complete the following table.

Year BTCF Depreciation T.I. Taxes ATCF

0
1
2
3
4
5
PART 2 Does the sum-of-years-digits depreciation represent a cash flow?
PART 3. Calculate the before-tax rate of return and the after-tax rate of return.

Solution

PART 1:
Sum-of-years-digits Depreciation --

Year 1 = (100,000 - 20,000) = $26,667

Year 2 = (80,000) = $21,333

190 Chapter 13 Income Taxes
Year 3 = (80,000) = $16,000

Year 4 = (80,000) = $10,667

Year 5 = (80,000) = $ 5,333

Year BTCF Depreciation T.I. Taxes ATCF

0 -100,000 - - - -100,000
1 40,000 26,667 13,333 -5,333 34,667
2 40,000 21,333 18,667 -7,467 32,533
3 40,000 16,000 24,000 -9,600 30,400
4 40,000 10,667 29,333 -11,733 28,267
5 40,000 5,333 34,667 -13,867 26,133
5 20,000 - - - 20,000

PART 2:
The sum-of-years-digits depreciation is a bookkeeping allocation of capital expense for
purposes of computing taxable income. Therefore it does not represent an actual cash flow
(exchange of money).

PART 3:
Before tax ROR
NPW = 0 at IRR
0 = -100,000 + 40,000(P/A, i%, 5) + 20,000(P/F, i%, 5)
Try 30% * NPW = +2,826
Try 35% NPW = -6,740
By interpolation:
IRR = 31.5%

After tax ROR

NPW = 0 at IRR
0 = -100,000 + 34,667(P/A, i%, n) - 2,133(P/G, i%, n) + 20,000(P/F, i%, n)
Try 20% * NPW = +1,263
Try 25% NPW = -9,193
By interpolation:
IRR = 20.60%

*Caution should be exercised when interpolating to find an interest rate. Linear interpolation
is being imposed on a non-linear function. Therefore the solution is approximate. A
maximum range over which to interpolate and achieve generally good results is usually
 Chapter 13 Income Taxes 191
considered to be three percentage points. Often times the interest tables you have at your
disposal will force you to use a larger range. This is the case in this problem.

13-16
PARC, a large profitable firm, has an opportunity to expand one of its production facilities at a
cost of $375,000. The equipment is expected to have an economic life of 10 years and to have a
resale value of $25,000 after 10 years of use. If the expansion is undertaken, PARC expects that
their income will increase by $60,000 for year 1, and then increase by $5000 each year through
year 10. The annual operating cost is expected to be $5000 for the first year and to increase by
$250 per year thereafter. If the equipment is purchased, PARC will depreciate it using straight-
line to a zero salvage value at the end of year 8 for tax purposes. Since PARC is a large and
profitable firm their tax rate is 34%.

If PARCs minimum attractive rate of return (MARR) is 15%, should they undertake this
expansion?

Solution

Year Income Costs BTCF

1 60,000 5,000 55,000
2 65,000 5,250 59,750
3 70,000 5,500 64,500
4 75,000 5,750 69,250
5 80,000 6,000 74,000
6 85,000 6,250 78,750
7 90,000 6,500 83,500
8 95,000 6,750 88,250
9 100,000 7,000 93,000
10 105,000 7,250 97,750

Year BTCF Depreciation T.I. Taxes ATCF

0 -375,000 - - - -375,000.00
1 55,000 46,875 8,125 2,762.50 52,237.50
2 59,750 46,875 12,875 4,377.50 55,372.50
3 64,500 46,875 17,625 5,992.50 58,507.50
4 69,250 46,875 22,375 7,607.50 61,642.50
5 74,000 46,875 27,125 9,222.50 64,777.50
6 78,750 46,875 31,875 10,837.50 67,912.50
7 83,500 46,875 36,625 12,452.50 71,047.50
8 88,250 46,875 41,375 14,067.50 74,182.50
9 93,000 - 93,000 31,620.00 61,380.00
10 97,750 - 97,750 31,620.00 61,380.00
10 25,000 - 25,000 8,500.00 16,500.00

NPW = -375,000 + [52,237.50(P/A, 15%, 8) + 3,135(P/G, 15%, 8)] + 61,380(P/F, 15%, 9)

+ 77,880(P/F, 15%, 10)
192 Chapter 13 Income Taxes
NPW = -$64,780.13
PARC should not undertake the expansion.

13-17
A project under consideration by PHI Inc. is summarized in the table below. The company uses
straight-line depreciation, pays income taxes at the 30% marginal rate and requires an after-tax
MARR of return of 12%.
First Cost $75,000
Annual Revenues 26,000
Annual Costs 13,500
Salvage Value 15,000
Useful Life 30 years
a) Using net present worth, determine whether the project should be undertaken.
b) If the company used sum-of-the-years-digits depreciation, is it possible the decision would
change? (No computations needed.)

Solution

a) Year BTCF Depreciation T.I. Taxes ATCF

0 -75,000 - - - -75,000
1-30 12,500 2,000 10,500 3,150 9,350
30 15,000 - - - 15,000
NPW = -75,000 + 9,350(P/A, 12%, 30) + 15,000(P/F, 12%, 30) = $815
Yes, take project since NPW > 0

b) No. Although total depreciation is the same, SOYD is larger in the early years when it is
worth more. Therefore the NPW would increase with SOYD making the project even
more desirable.

13-18
A heat exchanger purchased by Hot Spot Manufacturing cost $24,000. The exchanger will save
$4,500 in each of the next 10 years. Hot Spot will use SOYD depreciation over a six-year
depreciable life. The declared salvage value is $3,000. It is expected the exchanger will be sold
for the declared value. Hot Spot pays taxes at a combined rate of 42% and has a MARR of 8%.
Was the purchased justified?

Solution
 Chapter 13 Income Taxes 193
Year
0 First Cost -24,000
1-10 Annual Savings 4,500(P/A, 8%, 10)(.58) 17,513
1-6 Depr. [6,000(P/A, 8%, 6) - 1,000(P/G, 8%, 6)](.42) 7,230
10 Capital Recovery 3,000(P/F, 8%, 10) 1,390
NPW $2,133
Yes the purchase was justified.

13-19
The Red Ranger Company recorded revenues of $45,000 and recaptured depreciation of $1,200
for the year just ended. During the year they incurred cash expenses of $23,500 and depreciation
expenses of $11,575. Red Rangers taxable income is

a. $9,925
b. $11,125
c. $21,500
d. $34,275

Solution

TI = revenues - expenses - depreciation + recaptured depreciation

= 45,000 - 23,500 - 11,575 + 1,200
= $11,125

The answer is b.

13-20
A project will require the investment of $108,000 in capital equipment (SOYD with a depreciable
life of eight years and zero salvage value) and $25,000 in other non-depreciable materials that will
be purchased during the first year. The annual net income realized from the is projected to be
$28,000. At the end of the eight years, the project will be discontinued and the equipment sold for
$24,000. Assuming a tax rate of 28% and a MARR of 10%, should the project be undertaken?

Solution

Cash expenses are multiplied by (1 - tax rate)

Incomes are multiplied by (1 - tax rate)
Depreciation is multiplied by tax rate
Recaptured depreciation is multiplied by (1 - tax rate)

Year
0 First Cost -108,000
1 Other Costs 25,000(P/F, 10%, 1)(.72) -16,364
1-8 Depr. [24,000(P/A, 10%, 8) - 3,000(P/G, 10%, 8)](.28) 22,387
1-8 Income 28,000(P/A, 10%, 8) 107,554
8 Recaptured Depr. 24,000(P/F, 10%, 8)(.72) 8,061
NPW $13,638
Project should be undertaken.
194 Chapter 13 Income Taxes

13-21
The Salsaz-Hot manufacturing company must replace a machine used to crush tomatoes for its
salsa. The industrial engineer favors a machine called the Crusher. Information concerning the
machine is presented below.

First Cost $95,000

Annual Operating Costs 6,000
Annual Insurance Cost* 1,750
Annual Productivity Savings 19,000
*Payable at the beginning of each year

Depreciable Salvage Value $10,000

Actual Salvage Value 14,000
Depreciable Life 6 yrs
Actual Useful Life 10 yrs
Depreciation Method SL

Property taxes equal to 5% of the first cost are payable at the end of each year.

Relevant financial information for Salsaz-Hot:

Marginal Tax Rate 34%
MARR 10%
Determine net present worth.

Solution

Cash expenses are multiplied by (1 - tax rate)

Incomes are multiplied by (1 - tax rate)
Depreciation is multiplied by tax rate
Capital recovery is not taxable therefore multiplied by 1
Recaptured depreciation is multiplied by (1 - tax rate)

Year
0 First Cost -95,000
1-10 Net Savings 13,000(P/A, 10%, 10)(.66) 52,724
1-10 Property Taxes .05(95,000)(P/A, 10%, 10)(.66) -19,265
0-9 Insurance [1,750 + 1,750(P/A, 10%, 9)](.66) -7,807
1-6 Depr. 14,167(P/A, 10%, 6)(.34) 20,977
10 Capital Recovery 10,000(P/F, 10%, 10) 3,855
10 Recaptured Depr. 4,000(P/F, 10%, 10)(.66) 1,018
NPW -$43,498
 Chapter 13 Income Taxes 195

13-22
Momma Mias Pizza must replace its current pizza baking oven. The two best alternatives are
presented below.
Crispy Cruster Easy Baker
Initial Cost $24,000 $33,000
Annual Costs 9,000 6,000
Depreciable Salvage Value 6,000 5,000
Actual Salvage Value 6,000 8,000
Depreciable Life 3 yrs 4 yrs
Actual Useful Life 5 yrs 5 yrs
Depreciation Method SL SOYD

Assume Momma pays taxes at the 34% rate and has a MARR of 8%. Which oven should be
chosen?

Solution

CC
Year
0 First Cost -24,000
1-5 Annual Costs 9,000(P/A, 8%, 5)(.66) -23,718
1-3 Depr. 6,000(P/A, 8%, 3)(.34) 5,257
5 Capital Recovery 6,000(P/F, 8%, 5) 4,084
NPW -$38,377
EB
Year
0 First Cost -33,000
1-5 Annual Costs 6,000(P/A, 8%, 5)(.66) -15,813
1-4 Depr. [11,200(P/A, 8%, 4) - 2,800(P/G, 8%, 4)](.34) 8,185
5 Capital Recovery 5,000(P/F, 8%, 5) 3,403
5 Recaptured Depreciation 3,000(P/F, 8%, 5)(.66) 1,348
NPW -$35,877
Choose the Easy Baker oven.

13-23
196 Chapter 13 Income Taxes
Pinion Potato Chip Inc., must purchase new potato peeling equipment for its Union City,
Tennessee plant. The plant engineer, Abby Wheeler, has determined that there are three possible
set-ups that could be purchased. Relevant data are presented below.

Naked Peel Skinner Peel-O-Matic

First Cost $45,000 $52,000 $76,000
Annual Costs 6,000 5,000 5,000
Declared Salvage Value 12% of FC 5,500 10,000
Useful Life 6 years 6 years 6 years
Actual Salvage Value 6,500 5,500 12,000

Part A All assets are depreciated using the SL method. Determine which set-up should be
chosen if P2C Inc. has a MARR of 10% and pays taxes at the 34% marginal rate.

Part B Due to economic considerations P2C Inc. must eliminate from consideration the Peel-O-
Matic set-up and because of a change in the tax laws they must use MACRS depreciation.
If all other information concerning the other two alternatives remains the same, which
should be chosen?

Solution

Part A
NP
Year
0 First Cost -45,000
1-6 Annual Costs 6,000(P/A, 10%, 6)(.66) -17,246
1-6 Depr. 6,600(P/A, 10%, 6)(.34) 9,773
6 Capital Recovery 5,400(P/F, 10%, 6) 3,048
6 Recaptured Depr. 1,100(P/F, 10%, 6)(.66) 410
NPW -$49,015
S
Year
0 First Cost -52,000
1-6 Annual Costs 5,000(P/A, 10%, 6)(.66) -14,372
1-6 Depr. 7,750(P/A, 10%, 6)(.34) 11,475
6 Capital Recovery 5,500(P/F, 10%, 6) 3,105
NPW -$51,792

POM
Year
0 First Cost -76,000
 Chapter 13 Income Taxes 197
1-6 Annual Costs 5,000(P/A, 10%, 6)(.66) -52,724
1-6 Depr. 11,000(P/A, 10%, 6)(.34) 16,288
6 Capital Recovery 10,000(P/F, 10%, 6) 5,645
6 Recaptured Depr. 2,000(P/F, 10%, 6)(.66) 745
NPW -$67,694
Choose Naked Peel.

Part B
NP
Year
0 First Cost -45,000
1-6 Annual Costs 6,000(P/A, 10%, 6)(.66) -17,246
1 Depr. (.3333)(45,000)(P/F, 10%, 1)(.34) 4,636
2 Depr. (.4445)(45,000)(P/F, 10%, 2)(.34) 5,620
3 Depr. (.1481)(45,000)(P/F, 10%, 3)(.34) 1,702
4 Depr. (.0741)(45,000)(P/F, 10%, 4)(.34) 774
6 Recaptured Depr. 6,500(P/F, 10%, 6)(.66) 2,422
NPW -$47,092
S
Year
0 First Cost -52,000
1-6 Annual Costs 5,000(P/A, 10%, 6)(.66) -14,372
1 Depr. (.3333)(52,000)(P/F, 10%, 1)(.34) 5,357
2 Depr. (.4445)(52,000)(P/F, 10%, 2)(.34) 6,494
3 Depr. (.1481)(52,000)(P/F, 10%, 3)(.34) 1,967
4 Depr. (.0741)(52,000)(P/F, 10%, 4)(.34) 895
6 Recaptured Depr. 5,500(P/F, 10%, 6)(.66) 2,049
NPW -$49,610
Choose Naked Peel.