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Homework answers / question archive / A company is considering investing in a capital project that requires an amount of $30,000 and is 6 years old, and the investment cost will be amortized for accounting and tax purposes over a period of 6 years
A company is considering investing in a capital project that requires an amount of $30,000 and is 6 years old, and the investment cost will be amortized for accounting and tax purposes over a period of 6 years. At a rate of $5,000 annually and without scrap, the annual net flows from the project before calculating the income tax amount to $10,000 , and the income tax rate is 40% to be paid at the end of each year, and the required annual rate of return on the project is 15%.
Required: Answer the following questions with clarification .
1- The project's accounting rate of return after tax is:
a)10% b)16.67% c)26.67% d)33.33%.
2- The amount of the payback period after income tax for the project amounts to:
a) 5 years b) 3.75 years c) 3.33 years d) 2 years.
3- The net present value of the investment project is:
a) ($7290) b) $280 c) $7850 d) $11760
Answers
1) c -26.67%
2) b -3.75 years
3) b $ 280
Workings
| Data Given in Question | ||||||
| a | Initial Investment amount | $ 30000 | ||||
| b | Investment Period | 6 Years | ||||
| c | Annual amortization amount | $ 5000 | ||||
| d | Annual net flows before tax | $ 10000 | ||||
| e | Income tax rate | 40% | ||||
| f | Required annual rate of return | 15% | ||||
| Answer | ||||||
| 1 | Project Accounting Rate of Return after tax is c) 26.67 as calculated below | |||||
| Calculations | ||||||
| Annual Net flowsafter tax | $ | |||||
| Annual net flows before tax | 10000 | |||||
| Less: Annual Amortization | 5000 | |||||
| Net Profit | 5000 | |||||
| Less: Tax @40% on net profit | 2000 | |||||
| Profit after tax | 3000 | |||||
| Add Annual amortization | 5000 | |||||
| Net flows after tax | 8000 | |||||
| Accounting Rate of Return = Net Inflows after tax/Initial Investment X100 | ||||||
| ie | 8000/30000 x 100 | |||||
| 26.66667 | ||||||
| 2 | Payback period after income tax is b) 3.75 years | |||||
| Calculations | ||||||
| Payback period = Investment/Estimated net cash inflow | ||||||
| 30000/8000=3.75 | ||||||
| 3 | Net Present value of investment project is b) $280 | |||||
| Calculations | ||||||
| Net present Values =Present Value of Cash inflows - Present value of Cash out flows | ||||||
| Present value of Cash out flows = Initial Investment = $ 30000 | ||||||
| Present value of Cash in flows is calculated below | ||||||
| Cash flow | PV Factor | Present Value | ||||
| Year 1 | 8000 | 0.8696 | 6956.8 | |||
| Year 2 | 8000 | 0.7562 | 6049.6 | |||
| Year 3 | 8000 | 0.6576 | 5260.8 | |||
| Year 4 | 8000 | 0.5718 | 4574.4 | |||
| Year 5 | 8000 | 0.4972 | 3977.6 | |||
| Year 6 | 8000 | 0.4323 | 3458.4 | |||
| Present Value of Cash inflows | 30277.6 | |||||
| Therefore Net Present Value = 30277.6 - 30000 | ||||||
| ie 277.6 or rouded to $ 280 | ||||||
