An injection molding machine can be purchased and installed for $70,000. It is i
ID: 2589036 • Letter: A
Question
An injection molding machine can be purchased and installed for $70,000. It is in the seven-year GDS property class and is expected to be kept in service for eight years. It is believed that $8,000 can be obtained when the machine is disposed of at the end of year eight. The net annual value added (i.e., revenues less expenses) that can be attributed to this machine is constant over eight years and amounts to $12,000. An effective income tax rate of 45% is used by the company, and the after-tax MARR equals 8% per year.Explanation / Answer
(a) Before tax MARR (1- tax rate) = After tax MARR
Before tax MARR (1- 0.45) = 0.08
Before tax MARR = 0.08 / 0.55 = 0.14545 or 14.55% (approx)
(b) It is a 7 year GDS property class so its purchase price should be written off as depreciation in 7 years.
GDS depreciation from year one through seven is $70000/7 = $10,000 and in year eight is 0
(c) As whole of value of property is written off as depreciation in 7 years, so the disposal value at the end of 8th year will be chargeable to tax as capital gains. Thus, taxable income at the end of year eight which is related to capital investment is $8000.
(d)
(e)
Thus purchase of the machine is not recommended as purchase price is less than Present value of cash inflows.
Calculation of ATCF Net annual value added 12000 Tax rate 45% After tax value added 6600 Tax savings on depreciation (inflow) 4500 (10000*45%) Total cash inflow 11100 ( year 1 to year 7) Terminal value 4400 (8000 - 8000 * 45%) Total cash inflow 15500 (year 8)