Consider the following two alternatives. Each alternative has a 10-year useful l

Question

Consider the following two alternatives. Each alternative has a 10-year useful life and no salvage value. If the combined tax rate is 35 %, calculate the annual straight-line depreciation and annual combined taxes for each alternative? If the MARR is 17.50%, which alternative is preferred? Answer in terms of incremental rate of return analysis . Cash Flow Initial cost Annual Operating Revenue Annual Operating Expenses (-$6,000) $3,000 -$1,000) (-$10,500) $4,750 (-S 1,500) B-A ($4,500) $1,750 (-S 500) Straight-line Depreciation Earnings Before Taxes Annual Combined Taxes After-tax Cash Flow

Explanation / Answer

first, we will calculate the incremental cash flow

Now we will calculate NPV using incremental cashflow

As NPV is coming negative Project B in not giving more NPV over project A.

Now lets calculate the NPV of project A

As for the project A NPV is coming positive project should be accepted.

Cashflow A B B-A a Initial Cashflow $       (6,000) $       (10,500) $       (4,500) b Annual operating Revenue $         3,000 $ 4,750 $         1,750 c Annual operating Exp $       (1,000) $         (1,500) $ (500) d Depreciation $ (600) $         (1,050) $ (450) e Earning befor tax $         1,400 $ 2,200 $             800 f Tax @35% $ (490) $ (770) $ (280) g Profit after tax $ 910 $ 1,430 $             520 h Cashflow after tax (g+d) $         1,510 $ 2,480 $             970

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