Clark starts a machine shop in Arab to do metalwork repairs and small jobs. He b
ID: 1097826 • Letter: C
Question
Clark starts a machine shop in Arab to do metalwork repairs and small jobs. He buys two lathes and a vertical milling machine for $42.000. He also buys. second hand. three Windows XP computer systems plus a printer. all for $800. to keep books. print invoices. and do purchasing. The equipment will be depreciated according to the schedules printed above. Clark estimates that. once he gets the equipment in place. he will sell 1.30.000 of work the first year and $60.000 of work the next 4 wars. Each year he will spend $8.000 on steel and S7.000 on rent. All the labor will be done by Clark and his daughter. and they will take no salary. Clark has set the business up as an S-corporation. and he and his daughter own all the shares. They both pay a tax rate of 29%. Estimate the take home pay for Clark and his daughter during each of the first five Years of operation. What is the net present value of the business for wars 0 to 5?Explanation / Answer
Calculations are shown in the table below-
Analysis:
1. Total amount initially invested is $42,000 for 2 Lathe and one vertical milling machine. Also $800 is spent for 3 windows computers. THus initial cash ouflow is $42,800.
2. Depreciation has been calculated at the rate prescribed for 5 years duration in the problem. It will not exhaust entire value of equipment cost. However nothing has been mentioned about the scrap value. So it is assumed that nothing will be recovered by selling machines after 5 years.
3. Depreciation is deductible for ascertainng take home income. It is also deducted for calculating tax payable. However for cash flow and NPV calculation it is added back since no cash is outflowing as depreciation.
4. For NPV calculation discount rate is requred. It is not mentioned in the problem. 10% rate has been assumed for the calculation stated above.
Results: Take home income :
Year 1 $4,508, $22,226, $26,115, $28,449 and $30,200. Some balance depreciation not recovered in the above figures. The residual amount may be deducted from last year income to ascertain net take home income of fifth year.
NPV at 10% assumed discount rate is $67,644.
Details Year 1 Year 2 Year 3 Year 4 Year 5 1. Sales $30,000 $60,000 $60,000 $60,000 $60,000 2.Steel $8,000 $8,000 $8,000 $8,000 $8,000 3. Rent $7,000 $7,000 $7,000 $7,000 $7,000 4. Depreciation (%) 20 32 19.2 11.52 5.76 5. Depreciation(in $) $8,560 $13,696 $8,218 $4,931 $2,465 6. Total cost (2+3+5) $23,650 $28,696 $23,218 $19,931 $17,465 7.Profit before tax [1-6] $6,350 $31,304 $36,782 $40,069 $42,535 8. Tax 29% on 7 $1,842 $9,078 $10,667 $11,620 $12,335 9.Profit after tax [7-8] $4,508 $22,226 $26,115 $28,449 $30,200 10.Net cash inflow[9+5] $13,068 $35,922 $34,333 $33,380 $32,665 11. Discounting factor at 10% 0.909 0.826 0.751 0.683 0.621 12. Present value of cash flow[10x11] $11,904 $29,672 $25,784 $22,799 $20,285 13. Total present value of inflow $110,444 14. Initial investment $42,800 15. Net present value [13-14] $67,644