Mitchell Bancorp is considering making a loan at 3% interest (c/a) to SohnCo to
ID: 2457075 • Letter: M
Question
Mitchell Bancorp is considering making a loan at 3% interest (c/a) to SohnCo to buy a machine tool worth $300 million. The tool has no salvage value and is depreciated over 3 years by sum-of-years digits. In this state, SohnCo pays 50% tax. The before-tax cash flow is estimated as $200M, $250M, and $300M over the three years. The CEO of Mitchell Bancorp has noticed that SohnCo has been losing money in this business sector by investing wildly in projects and cautions the use of an After-Tax MARR of at least 12%. Assume that Mitchell Bancorp makes this loan. Will SohnCo generate enough ATCF to pay back this loan???? Explain your answer
Explanation / Answer
Evaluation of loan proposal
Calculation of After Tax Cash Flows ($ in millions)
P.V. of after tax cash flows = 175x2.402 = 420.35
Decision: Yes. SohnCo will generate enough cah flows to pay back the loan
Workin Notes:
Calculation of depreciation per year and tax savings on depreciation
Depreciation = Depreciable Base x Remaining useful life/Sum of year digits
Sum of year digits = n(n+1)/2
= 3(3+1)/2 = 6
Particulars 1 2 3 Cash flows before tax 200 250 300 Less: Tax @50% (100) (125) (150) Add: Tax Savings on Depreciation 75 50 25 After Tax Cash flows 175 175 175