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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
Expert Solution
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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
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