A corporation with $7 million in annual taxableincome is

An unmarried taxpayer with no dependents expectsan adjusted gross income of $70,000 in a givenyear. His nonbusinessdeductions are expected to be$6000. (a)What will his federal income tax be?(b)He is considering an additional activityexpected to increase his adjusted gross income.If this increase should be $16,000 and thereshould be no change in nonbusiness deductionsor exemptions, what will be the increase in hisfederal income tax?

John Adams has a $65,000 adjusted gross incomefrom Apple Corp. and allowable itemized deduc- tions of $7200. Mary Eve has a $75,000 adjustedgross income and $2000 of allowable itemizeddeductions. Compute the total tax they would payas unmarried individuals. Then compute their tax asa married couple filing a joint return

Bill Jackson had a total taxable income of $1800.Bills employer wants him to work another monthduring the summer, but Bill had planned to spendthe month hiking. If an additional months workwould increase Bills taxable income by$1600,howmuch more money would he have after paying theincome tax?

A married couple filing jointly have a combinedtotal adjusted gross income of $75,000. They havecomputed that their allowable itemized deductionsare $4000. Compute their federal income tax.

Jane Shay operates a management consultingbusiness.The business has been successfuland nowproduces a taxable income of $100,000 per yearafter all ordinary and necessary expenses anddepreciation have been deducted. At present thebusiness is operated as a proprietorship; that is,Jane pays personal federal income tax on the entire$100,000. For tax purposes, it is as if she had a jobthat pays her a $100,000 salary per year.As an alternative, Jane is consideringincorporating the business. If she does, she willpay herself a salary of $40,000 a year from the cor-poration. The corporation will then pay taxes onthe remaining $60,000 and retain the balance of themoney as a corporate asset.Thus Janestwo alterna-tives are to operate the business as a proprietorshipor as a corporation. Jane is single and has $3500of itemized personal deductions. Which alternativewill result in a smaller total payment of taxes tothegovernment?(Answer:Incorporation, $14,180versus $19,102)

Bill Alexander and his wife, Valerie, are bothemployed. Bill will have an adjusted gross incomethis year of $70,000. Valerie has an adjusted gross income of $2000 a month. Bill and Valerie haveagreed that Valerie should continue working onlyuntil the federal income tax on their joint incometax return becomes $11,500. On what date shouldValerie quit her job?

An unmarried individualin California with a taxableincome of about $80,000 has a federal incrementaltax rate of 28% and a state incremental tax rate of9.3%. What is his combined incremental tax rate?

A$10,000commercialbondthathasa10%bondrateand matures in 5 years can be purchased for $8000.Interest is paid at the end of each year for the next 5years. Find the annual after-tax rate of return of thisinvestment. Assume a 35% tax rate applies.Contributed by D. P. Loucks,Cornell University

Given the following data, compute your combinedincome tax rate (CTR) assuming you deduct allow- ableexpensesonyourincometaxforms:abefore-taxMARRof5%,aninflationrateof3%,afederalincometax rate of 28%,a state income tax rate of 6%, a localcity income tax of 3%, and a capital gains tax rate of15%, as applicable.Contributed by D. P. Loucks,Cornell University

Using the answer from Problem 12-9, set up theequation to compute the after-tax rate of return foreach scenario:(a)A $5000 corporate bond costs $4600, paying$500 interest at the end of each yearfor the next5 years. At the end of 5 years you get $5000.(b)A federal-income-tax-free (on interest only)municipal bond costing $3000, paying $250 atthe end ofeach yearfor5 years,and $2500 attheend of the 5 years. State and local income taxesmust be paid.(c)A tax-deferred savingsplan in which you invest$4000 for 5 years. The plan earns 8% annualinterest and you get back your $4000 plus inter-est at the end of 5 years.Contributedby D. P. Loucks,CornellUniversity

A company wants to set up a new office in a countrywhere the corporate tax rate is as follows: 15% offirst $50,000 profits, 25% of next $25,000, 34% ofnext$25,000,and 39%ofeverything over$100,000.Executives estimate that they will have gross rev-enues of $500,000,total costs of $300,000, $30,000in allowable tax deductions,anda one-time businessstart-up credit of $8000. What is taxable income forthe first year, and how much should the companyexpect to pay in taxes?

ARKO oil company purchased two largecompressors for $125,000 each. One compres-sor was installed in the firms Texas refinery andis being depreciated by MACRS depreciation.The other compressor was placed in the Okla-homa refinery, where it is being depreciated bysum-of-years- digits depreciation with zero salvagevalue. Assume the company pays federal incometaxes each year and the tax rate is constant. Thecorporate accounting department noted that the twocompressors are being depreciated differently andwonders whether the corporation will wind up pay-ing more income taxesover the life ofthe equipmentas a result of this. What do you tell them?

Sole Brother Inc. is a shoe outlet to a major shoemanufacturing industry located in Chicago. SoleBrother uses accounts payable as one of its financ-ing sources. Shoes are delivered to Sole Brotherwith a 3% discount if payment on the invoice isreceived within 10 days of delivery. By paying afterthe 10-day period, Sole is borrowing money andpaying (giving up) the 3% discount. Although SoleBrother is not required to pay interest on delayedpayments, the shoe manufacturers require that pay-ments not be delayed beyond 45 days after theinvoice date. To be sure of paying within 10 days,Sole Brothers decides to pay on the fifth day. Solehas a marginal corporate income tax of 40% (com-bined state and federal). By paying within the 10-day period, Sole is avoiding paying a fairly highprice to retain the money owed shoe manufacturers.What would have been the effective annualafter-taxinterest rate?

A major industrialized state has a state corporatetax rate of 9.6% of taxable income. If a corporationhas a state taxable income of $150,000, what is thetotal state and federal income tax it must pay? Also,compute its combined incremental state and federalincome tax rat

To increase its market share, Sole Brother Inc.decided to borrow $50,000 from its banker for thepurchase of newspaperadvertising for its shoe retailline. The loan is to be paid in four equal annualpayments with 15% interest. The loan is discounted12 points. The first 6 points are an additionalinterest charge of 6% of the loan, deducted immedi-ately.This additionalinterest6%(50,000)=$3000means the actual amount received from the $50,000loan is $47,000. Another 6 points or $3000 of addi-tional interest is deducted as four $750 additionalannualinterestpayments.Whatis the after-tax inter-est rate on this loan

The Lynch Bull investment company suggeststhat Steven Comstock, a wealthy New York Cityinvestor (his incremental income tax rate is 35%),consider the following investment.Buy corporate bonds on the New York StockExchange with a face value (par value) of $100,000and a 5% interest rate paid annually. These bondscan be purchased at their present market value of$75,000. Each year Steve will receive the $5000interest, and after 5 years, when the bonds mature,he will receive $100,000 plus the last $5000 ofinterest.Steve will pay for the bonds by borrowing$50,000 at 10% interest for 5 years. The $5000interest paid on the loan each year will equal the$5000of interest income from the bonds.As a resultSteve will have no net taxable income during thefive years due to this bond purchase and borrowingmoney scheme.At the end of 5 years, Steve will receive$100,000 plus $5000 interest from the bonds andwill repay the $50,000 loan and pay the last $5000interest. The net result is that he will have a $25,000capital gain; that is, he will receive $100,000from a $75,000 investment. (Note:This situationrepresentsan actualrecommendationof a brokeragefirm.)(a)Compute Steves after-tax rate of returnon this dual bond-plus-loan investmentpackage.(b)What would be Steves after-tax rate of returnif he purchased the bonds for $75,000 cash anddid notborrow the $50,000?

Albert Chan decided to buy an old duplex as aninvestment. After looking for several months, hefound a desirable duplex that could be bought for$300,000 cash. He decided that he would rent bothsides of the duplex, and determined that the totalexpected income would be $1500 per month. Thetotal annual expenses for property taxes, repairs,gardening, and so forth are estimated at $750 peryear. For tax purposes, Al plans to depreciatethe building by the sum-of-years-digits method,assuming that the building has a 20-year remaininglife and no salvage value. Of the total $300,000 costof the property, $250,000 represents the value of thebuilding and $50,000 is the value of the lot. Assumethat Al is in the 38%incremental income tax bracket(combined state and federal taxes) throughout the20 years. In this analysis Al estimates that the income andexpenses will remain constant at their present levels.If he buys and holds the property for 20 years, whatafter-tax rate of return can he expectto receive on hisinvestment, using the following assumptions?A.Al believes the building and the lot can be soldat the end of 20 years for the $50,000 estimatedvalue of the lot.B.A more optimistic estimate of the future valueof the building and the lot is that the prop-erty can be sold for $380,000 at the end of20 years

Zeon, a large, profitable corporation, is consideringadding some automatic equipment to its productionfacilities. An investment of$120,000will produce aninitial annual benefit of $29,000, but the benefits areexpected to decline $3000 per year, making second-year benefits $26,000, third-year benefits $23,000,and so forth. If the firm uses sum-of-years-digitsdepreciation, an 8-year useful life, and $12,000 sal-vage value,will it obtain the desired 6% after-tax rateof return? Assume that the equipment can be sold forits $12,000 salvage value at the end of the 8 years.Also assume a 46% income tax rate for state andfederal taxes combined.

A group of businessmen formed a corporation tolease for 5 years a piece of land at the intersectionof two busy streets. The corporation has invested$50,000 in car-washing equipment. They will depre- ciate the equipment by sum-of-years-digits depre-ciation, assuming a $5000 salvage value at theend of the 5-year useful life. The corporation isexpected to have a before-tax cash flow, after meet-ing all expenses of operation (except depreciation),of $20,000 the first year, declining $3000 per yearin future years (second year=$17,000, third year=$14,000, etc.). The corporation has other income,so it is taxed at a combined corporate tax rate of 20%.If the projected income is correct, and the equipmentcan besold for $5000at the endof5 years,whatafter-tax rate of return would the corporation receive fromthis venture?

The effective combined tax rate in an owner-managed corporation is 40%. An outlay of $2million for certain new assets isunder consider-ation. It is estimated that for the next 8 years,these assets will be responsible for annual receiptsof $600,000 and annual disbursements (other thanfor income taxes) of $250,000. After this time,they will be used only for stand-by purposes, andno future excess of receipts over disbursements isestimated (a)What is the prospective rate of return beforeincome taxes?(b)What is the prospective rate of return after taxesif straight-line depreciation can be used to writeoff these assets for tax purposes in 8 years?(c)What is the prospective rate of return after taxesif it is assumed that these assets must be writtenoff for tax purposes over the next 20 years, usingstraight-line depreciation?

A firm is considering the following investmentproject:Before-TaxCash FlowYear (thousands)0$10001 5002 3403 2444 1005?100125 Salvage value?The project has a 5-year useful life with a $125,000salvage value, as shown. Double declining balancedepreciation will be used, assuming the $125,000salvagevalue. The combined income tax rate is 34%.If the firm requires a 10% after-tax rate of return,should the project be undertaken?

The Shellout Corp. owns a piece of petroleumdrilling equipment that costs$100,000 and will bedepreciated in 10 years by double declining balancedepreciation, with conversion to straight-line depre-ciation at the optimal point. Assume no salvagevaluein the depreciationcomputation anda combined34%tax rate. Shellout will lease the equipment to othersand each year receive $30,000 in rent. At the end of5 years, the firm will sell the equipment for $35,000.(Note that this is different from the zero-salvage-value assumption used in computing the deprecia-tion.) What is the after-tax rate of return Shellout willreceive from this equipment investment?

A mining corporation purchased $120,000 ofproduction machinery and depreciated it usingSOYD depreciation, a 5-year depreciable life, andzero salvage value. The corporation is a profitableone that has a 34% combined incremental tax rate.At the end of 5 years the mining companychanged its method of operation and sold theproduction machinery for $40,000. During the 5years the machinery was used, it reduced mine oper-ating costs by $32,000 a year, before taxes. If the company MARR is 12% after taxes, was the invest-ment in the machinery a satisfactory one?

An automaker is buying some special tools for$100,000. The tools are being depreciated by dou-ble declining balance depreciation using a 4-yeardepreciable life and a $6250 salvage value. It isexpected the tools will actually be kept in servicefor 6 years and then sold for $6250. The before- taxbenefit of owning the tools is as follows:Before-TaxYearCashFlow1 $30,0002 30,0003 35,0004 40,0005 10,0006 10,0006,250 Selling priceCompute the after-tax rate of return for thisinvestment situation, assuming a 46% incrementaltax rate.

This is the continuation of Problem 12-24.Instead of paying $100,000 cash for the tools, thecorporation will pay $20,000 now and borrow theremaining $80,000. The depreciation schedule willremain unchanged. The loan will be repaid by 4equal end-of-year payments of $25,240.Prepare an expanded cash flow table that takesinto account both the special tools and the loan.(a)Compute the after-tax rate of return forthe tools, taking into account the $80,000loan.(b)Explain why the rate of return obtained in part(a)is different from the rate of return obtainedin Problem 12- 24.Hints:1.Interest on the loan is 10%, $25,240=80,000 (A/P, 10%, 4). Each paymentis made up of part interest and partprincipal. Interest portion for any year is10% of balance due at the beginning ofthe year.2.Interest payments are tax deductible (i.e.,they reduce taxable income and thus taxespaid). Principal payments are not. Separateeach$25,240paymentinto interest and prin-cipal portions.3.The Year-0 cash flow is$20,000 4.After-tax cash flow will be before-taxcash flow interest payment principalpayment taxes.

A project will require the investment of $108,000 inequipment (sum-of-years-digits depreciation witha depreciable life of 8 years and zero salvage value)and $25,000 in raw materials (not depreciable).The annual project income after all expenses exceptdepreciation have been paid is projected to be$24,000. At the end of 8 years the project will bediscontinued and the $25,000 investment in rawmaterials will be recovered.Assume a 34% combined income tax rate forthis corporation. The corporation wants a 15%after-tax rate of return on its investments. Deter-mine by present worth analysis whether this projectshould be undertaken

A profitable incorporated business is consideringan investment in equipment having the follow-ing before-tax cash flow. The equipment will bedepreciated by double declining balance deprecia-tion with conversion, if appropriate, to straight-linedepreciation at the preferred time. For depreciationpurposes a $700,000 salvage value at the end of 6years is assumed. But the actual value is thought tobe $1,000,000,and it is this sum that is shown in thebefore-tax cash flow.Before- TaxCashFlowYear(in $1000)0$12,00011,72722,41432,87243,17753,35861,9971,000 Salvage valueIf the firm wants a 9% after-tax rate of return andits combined incremental income tax rate is 34%,determine by annual cash flow analysis whether theinvestment is desirable.

A salad oil bottling plant can either buy caps forthe glass bottles at 5?c each or install $500,000worth of plastic molding equipment and manufac-ture the caps at the plant. The manufacturing engi-neer estimates the material, labor, and other costswould be 3?c per cap. (a)If 12 million caps per year are needed andthe molding equipment is installed, what is thepayback period?(b)The plastic molding equipment would bedepreciated by straight-line depreciation usinga 5-year useful life and no salvage value.Assuming a combined 40% income tax rate,what is the after-tax payback period, and whatis the after-tax rate of return?

A firm has invested $14,000 in machinery witha 7-year useful life. The machinery will have nosalvage value, as the cost to remove it will equalits scrap value. The uniform annual benefits fromthe machinery are $3600. For a combined 47%income tax rate, and sum-of-years-digits depreci-ation, compute the after-tax rate of return.

A firm manufactures padded shipping bags. Acardboard carton should contain 100 bags, butmachine operators fill the cardboard cartons by eye,so a carton may contain anywhere from 98 to 123bags (average=105.5 bags).Managementrealizes that they are giving away51/2% of their output by overfilling the cartons.The solution would be to weigh each filled ship-ping carton. Underweight cartons would have addi-tional shipping bags added, and overweight cartonswould have some shipping bags removed. If theweighing is done, it is believed that the averagequantity of bags per carton could be reduced to102, with almost no cartons containing fewer than100 bags.The weighing equipment would cost $18,600.The equipment would be depreciated bystraight-line depreciation using a 10-year depre-ciable life and a $3600 salvage value at the end of10 years. Assume the $18,600 worth of equipmentqualifies for a 10% investment tax credit. One per-son, hired at a cost of $16,000 per year, would berequired to operate the weighing equipment andto add or remove padded bags from the cardboardcartons. 200,000 cartons will be checked on theweighing equipment each year, with an averageremoval of 3.5 padded bags per carton with a man-ufacturing cost of 3?c per bag. This large profitablecorporation has a 50% combined federal-plus-stateincremental tax rate. Assumea 10-yearstudy periodfor the analysis and an after-tax MARR of 20%.Compute:(a)The after-tax present worth(b)The after-tax internal rate of return(c)The after-tax simple payback period

ACDC Company is considering the installation of anew machine that costs $150,000. The machine isexpected to lead to net income of $44,000 per yearfor the next 5 years. Using straight-line deprecia- tion, $0 salvage value, and an effective income taxrate of 50%, determine the after-tax rate of return forthis investment. If the companys after-tax MARRrate is 12%, would this be a good investmentor not?

Florida Construction Equipment Rentals (FCER)purchases a new 10,000-pound-rated crane forrental to its customers. This crane costs $1,125,000and is expected to last for 25 years, at which time itwill have an expected salvage value of $147,000.FCER earns $195,000 before-tax cash flow eachyear in rental income from this crane, and its totaltaxable income each year is between $10M and$15M. If FCER uses straight-line depreciation anda MARR of 15%, what is the present worth ofthe after-tax cash flow for this equipment? Shouldthe company invest in this crane

A computer-controlled milling machine will costAjax Manufacturing $65,000 to purchase plus$4700 to install.(a)If the machine would have a salvage value of$6600 at EOY 20, how much could Ajax chargeannually to depreciation of this equipment?Ajax uses straight-line depreciation.(b)What is the book value of the machine atEOY 3?(c)Ajax Manufacturing earnsa net profitbefore tax(also called a taxable income) of $28,800,000.How much tax would Ajax owe for this year?Contributed by Paul R. McCright, University ofSouth Florida

A farmer bought a new harvester for $120,000. Theharvesters operating expenses averaged $10,000per year but the harvester saved $40,000 per yearin labor costs. It was depreciated over a life of 5years using the SOYD method, assuming a salvagevalue of $30,000. The farmer sold the harvester foronly $10,000 at the end of the fifth year. Given anincome tax rate of 30% and a MARR rate of 5%per year, determine the after-tax net present worthof this investment.

Mr. Sam K. Jones, a successful businessman, isconsidering erecting a small building on a com- mercial lot. A local furniture company is willing tolease the building for $9000 per year, paid at theend of each year. It is a net lease, which meansthe furniture company must also pay the propertytaxes, fire insurance, and all other annual costs.The furniture company will require a 5-year leasewith an option to buy the building and land onwhich it stands for $125,000after 5 years.Mr. Jonescould have the building constructed for $82,000.He could sell the commercial lot now for $30,000,the same price he paid for it. Mr. Jones files ajoint return and has an annual taxable income fromother sources of $63,900. He would depreciate thecommercial building by modified accelerated costrecovery system (MACRS) depreciation. Mr. Jonesbelieves that at the end of the 5-year lease he couldeasily sell the property for $125,000. What is theafter-tax present worth of this 5-year venture if Mr.Jones uses a 10% after-tax MARR?

One January Gerald Adair bought a small houseand lot for $99,700. He estimated that $9700 ofthis amount represented the lands value. He rentedthe house for $6500 a year during the 4 yearshe owned the house. Expenses for property taxes,maintenance, and so forth were $500 per year. Fortax purposes the house was depreciated by MACRSdepreciation (27.5-year straight-line depreciationwith a midmonth convention is used for rentalproperty). At the end of 4 years the property wassold for $105,000. Gerald is married and worksas an engineer. He estimates that his incrementalstate and federal combined tax rate is 24%. Whatafter-tax rate of return did Gerald obtain on hisinvestment

A corporation with a 34% combined income taxrate is considering the following investment inresearchequipmentand hasprojected the benefitsasfollows:Before-TaxYear Cash Flow0$5,000,0001200,0002800,00031,760,00041,376,0005576,0006288,000 Prepare an after-tax cash flow table assumingMACRS depreciation.(a)What is the after-tax rate of return?(b)What is the before-tax rate of return?

An engineer is working on the layout of a newresearch and experimentation facility. Two plantoperators will be required.If, however,an additional$100,000 of instrumentation and remote controlswere added, the plant could be run by a singleoperator. The total before-tax cost of each plantoperator is projected to be $35,000 per year. Theinstrumentation and controls will be depreciated bymeans of the modified accelerated cost recoverysystem (MACRS).If this corporation (34% combined corporatetax rate) invests in the additional instrumentationand controls, how long will it take for the after-taxbenefits to equal the $100,000 cost? In other words,what is the after-tax payback period?

A special power tool for plastic products costs$400,000 has a 4-year useful life, no salvage value,and a 2-year before-tax payback period. Assumeuniform annual end-of-year benefits.(a)Compute the before-tax rate of return.(b)Compute the after-tax rate of return, based onMACRS depreciation and a 34% combinedcor-porate income tax rate

The Ogi Corporation, a construction company, pur-chased used a pickup truck for $14,000 and usedMACRS depreciation in the income tax return. Dur-ing the time the company had the truck, they esti-mated that it saved $5000 a year. At the end of 4years, Ogi sold the truck for $3000. The combinedfederal and state income tax rate for Ogi is 45%.Compute the after-tax rate of return for the truck.

A profitable wood products corporation isconsidering buying a parcel of land for $50,000,building a small factory building at a cost of$200,000, and equipping it with $150,000 ofMACRS 5-year-class machinery.If the project is undertaken, MACRS deprecia-tion will be used. Assume the plant is put in serviceOctober 1. The before-tax net annual benefit fromthe project is estimated at $70,000 per year. Theanalysisperiod is to be 5 years,and planners assumethe sale of the total property (land, building, andmachinery) at the end of 5 years, also on October1, for $328,000. Compute the after-tax cash flow based on a 34% combined income tax rate. If thecorporations criterion is a 15% after-tax rate ofreturn, should it proceed with the project?

A chemical company bought a small vessel for$55,000; it is to be depreciated by MACRSdepreciation. When requirements changed sud-denly, the chemical company leased the vessel toan oil company for 6 years at $10,000 per year.The lease also provided that the oil company couldbuy the vessel at the end of 6 years for $35,000.At the end of the 6 years, the oil company exer- cised its option and boughtthe vessel.The chemicalcompany has a 34% combined incremental tax rate.Compute its after-tax rate of return on the vessel

Xon, a small oil company, purchased a newpetroleum drilling rig for $1,800,000. Xon willdepreciate the drilling rig using MACRS deprecia-tion. The drilling rig has been leased to a drillingcompany, which will pay Xon $450,000 per yearfor 8 years. At the end of 8 years the drilling rigwill belong to the drilling company. If Xon hasa 34% combined incremental tax rate and a 10%after-tax MARR, does the investment appear to be satisfactory?

The profitable Palmer Golf Cart Corp. isconsidering investing $300,000 in special tools forsome of the plastic golf cart components. Execu-tives of the company believe the present golf cartmodel will continue to be manufactured and soldfor 5 years, after which a new cart design will beneeded,togetherwith a different set of specialtools.The saving in manufacturing costs, owing tothe special tools, is estimated to be $150,000 peryear for 5 years. Assume MACRS depreciation forthe special tools and a 39% combined income taxrate.(a)What is the after-tax payback period for thisinvestment?(b)If the company wants a 12% after-tax rate ofreturn, is this a desirable investment?

Uncle Elmo is contemplating a $10,000 investmentin a methane gas generator. He estimates his grossincome would be $2000 the first year and increaseby $200 each year over the next 10 years. Hisexpenses of $200 the first year would increase by$200 each year over the next 10 years. He woulddepreciate the generator by MACRS depreciation,assuming a 7-year property class. A 10-year- oldmethane generatorhas no marketvalue. The income tax rate is 40%. (Remember that recaptured depre-ciation is taxed at the same 40% rate.)(a)Construct the after-tax cash flow for the 10- yearproject life.(b)Determine the after-tax rate of return on thisinvestment. Uncle Elmo thinks it should be atleast 8%.(c)If Uncle Elmo couldsellthe generatorfor $7000at the end of the fifth year, would his rate ofreturn be better than if he kept the generator for10 years? You dont have to actually find therate of return, just do enoughcalculations to seewhether it is higher than that of part (b).

Grannys Butter and Egg Business is such thatshe pays an effective tax rate of 40%. Granny isconsidering the purchase of a new Turbo Churn for$25,000. This churn is a special handling devicefor food manufacture and has an estimated life of 4years and a salvage value of $5000. The new churnis expected to increase net income by $8000 peryear for each of the 4 years of use. If Granny workswith an after-tax MARR of 10% and uses MACRSdepreciation, should she buy the churn?

Eric has a house and lot for sale for $210,000. It isestimated that $40,000 is the value of the land and$170,000 is the value of the house. On January 1Bonnie is purchasing the house to rent and plansto own it for 5 years. After 5 years, it is expectedthat the house and land can be sold on December 31for $225,000. Total annual expenses (maintenance,property taxes, insurance, etc.) are expected to be$5000 per year. The house would be depreciatedby MACRS depreciation using a 27.5- year straight-line rate with midmonth convention for rental prop-erty. For depreciation, a salvage value of zero wasused.Bonnie wants a 15% after-tax rate of return onher investment. You may assume that Bonnie has anincremental income tax rate of 28% in each of the5 years. Capital gains are taxed at 15%. Determinethe following:(a)The annual depreciation(b)The capital gain (loss) resulting from the sale ofthe house(c)The annual rent Bonnie must charge to producean after-tax rate of return of 15%. (Hint:Writean algebraic equation to solve for rent.)

Bill owns a data processing company. He plans tobuy an additional computer for $20,000, use thecomputer for 3 years, and sell it for $10,000. Heexpects that use of the computer will produce a net Problems433TABLE P12-48Worksheet for Problem 12-48Before-Tax MACRS Taxable Income After-Tax PresentYear Cash Flow Depreciation Income Tax (45%) Cash Flow Worth (12%)0$20,0001 8,0002 8,0003 8,00010,000Net Present Worth=income of $8000 per year. The combined fed-eral and state incremental tax rate is 45%. UsingMACRS depreciation, complete Table P12-48 todetermine the net presentworth of the after-tax cashflow using an interest rate of 12%.

Refer to Problem 12-40. To help pay for the pickuptruck, the Ogi Corp. obtained a $10,000 loan fromthe truck dealer, payable in four end-of-year pay-ments of $2500 plus 10% interest on the loan bal-ance each year.(a)Compute the after-tax rate of return for the trucktogether with the loan. Note that the intereston the loan is tax deductible, but the $2500principal payments are not.(b)Why is the after-tax rate of return computedin part (a) so much different from the 12.5%obtained in Problem 12- 40?

Specialty Machining, Inc. bought a new multi turretturning centerfor $250,000.The machine generatednew revenue of $80,000 per year. Operating costsfor the machine averaged $10,000 per year. Follow-ing IRS regulations, the machine was depreciatedusing the MACRS method, with a recovery periodof 7 years. The center was sold for $75,000 after5 years of service. The company uses an after-taxMARR rate of 12% and is in the 35% tax bracket. Determine the after-tax net present worth of thisasset over the 5-year service perio

Fleet Fleet rental car company purchased 10 newcars for a total cost of $180,000. The cars generatedincome of $150,000 per yearand incurred operatingexpenses of $60,000 per year. The company usesMACRS depreciation and its marginal tax rate is40% (Note:Per IRS regulations, cars have a classlife of 5 years). The 10 cars were sold at the endof the third year for a total of $75,000. Assum-ing a MARR of 10% and using NPW, determineif this was a good investment on an after-tax basis.

An investor bought a racehorse for $1 million.The horses average winnings were $700,000 peryear and expensesaveraged $200,000 per year. Thehorse was retired after 3 years, at which time it wassold to a breeder for $175,000. Assuming MACRSdepreciation and an income tax rate of 50%, deter-mine the investors after-tax rate of return on thisinvestment.Contributed by Mukasa Ssemakula, Wayne StateUniversity

Vanguard Solar Systems is building a new manu-facturing facility to be used for the production ofsolar panels. Vanguard uses a MARR of 15%, andMACRS depreciation on its assetsand is in the 35%tax bracket. The building will cost $2.75 million,and the equipment (3-year property) will cost $1.55million plus installation costs of$135,000. O&Mcosts are expected to be $1.3 million the first year,increasing 6% annually. If the facility opens in themonth of March and sales are as shown, determinethe present worth of the after-tax cash flows for thefirst 5 years of operation.Contributed by Paul R. McCright, University ofSouth FloridaYear Sales1 $2,100,0002 3,200,0003 3,800,0004 4,500,0005 5,300,000

Tampa Electric Company (TECO) is planning amajor upgrade in its computerized demand man- agement system. In order to accommodate thisupgrade, a building will be constructed on landalready owned by the company. The building is esti-mated to cost $1.8M and will be opened in August2010. The computer equipment for the buildingwill cost $2.75M, and all office equipment willcost $225,000. Annual expenses for operating thisfacility (labor, materials, insurance, energy, etc.)are expected to be $325,000 during 2010. Use ofthe new demand management system is expectedto decrease fuel and other costs for the companyby $1.8M in the first year (2010). If the companyexpects to earn 9% on its investments, is in the 35%tax bracket, and uses a 20-year planning horizon,determine the estimated after-tax cash flow fromthis project in 201

Christopher wants to add a solar photovoltaic sys-tem to his home. He plans to install a 2-kW systemand has received a quote from an installer whowill install this unit for $19,750. The federal gov- ernment will give him a tax credit of 30% of the cost, and the state will give a 10% tax credit. Statelaw requires the utility company to buy back allexcess power generated by the system. Christo-phers annual power bill is estimated to be $2000,and this will be eliminated by the solar system.Christopher expects to receive a check from thepower company for $600 each year for his excessproduction. If the tax credits are received at EOY1 and Christopher receives a $2000 savings plus a$600 income at the end of each year, use presentworth to determine if the system pays for itself in8 years? Assume that Christopher earns 3% on allinvestments.Contributed by Paul R. McCright, University ofSouth Florida

Mid-America Shipping is considering purchasing anew barge for use on its Ohio River routes. Thenew barge will cost $13.2 million and is expectedto generate an income of $7.5 million the first year(growing $1M each year), with additional expensesof $2.6 million the first year (growing$400,000 peryear). If Mid-America uses MACRS, is in the 38%tax bracket, and has a MARR of 12%, what is thepresent worth of the first 4 years of after-tax cashflows from this barge? Would you recommend thatMid-America purchase this barge? (Hints: Remem-berthat all expensesare deductedfrom income priorto determining the taxes. Round to the nearest tenthof a million dollars.)Contributed by Paul R. McCright, University ofSouth Florida

A store owner, Joe Lang, believes his business hassuffered from the lack of adequate customer park- ing space. Thus, when he was offered an oppor-tunity to buy an old building and lot next to hisstore, he was interested. He would demolish the oldbuilding and make off-street parking for 20 cus-tomers cars. Joe estimates that the new parkingwould increase his business and produce an addi-tional before-income-tax profit of $7000 per year. Itwould cost $2500 to demolish the old building.Mr. Langs accountant advised that both costs(the property and demolishing the old building)would be considered to comprise the total valueof the land for tax purposes, and it would not be depreciable Mr. Lang would spend an additional $3000 rightaway to put a light gravel surface on the lot. Thisexpenditure, he believes, may be charged as anoperatingexpenseimmediately andneednotbe cap-italized. To compute the tax consequencesof addingthe parking lot, Joe estimates that his combined stateandfederalincrementalincome tax rate will average40%.If Joewantsa 15%after-tax rate of return fromthis project, how much could he pay to purchase theadjoining land with the old building?Assume that the analysis period is 10 years andthat the parking lot could always be sold to recoverthe costsof buying the property anddemolishing theold building.

The managementof a private hospitalis consideringthe installation of an automatic telephone switch- board, which would replace a manual switchboardand eliminate the attendant operators position. Theclass of service provided by the new equipmentis estimated to be at least equal to the presentmethod of operation. To provide telephone service,five operators currently work three shifts per day,365 days per year. Each operator earns $25,000per year. Company-paid benefits and overhead are25% of wages.Money costs 8% after income taxes.Combined federal and state income taxes are 40%.Annual property taxes and maintenance are 21/2and 4% of investment, respectively. Depreciationis 15-year straight line. Disregarding inflation,how large an investment in the new equipmentcan be economically justified by savings obtainedby eliminating the present equipment and laborcosts? The existing equipment has zero salvagevalue.

A contractor has to choose one of the followingalternatives in performing earthmoving contracts:A.Buy a heavy-duty truck for $35,000. Salvagevalue is expected to be $8000 at the end of thevehicles 7-year depreciable life. Maintenanceis $2500 per year. Daily operating expenses are$200.B.Hire a similar unit for $550 per day.Based on a 10% after-tax rate of return, how manydays per year must the truck be used to justify itspurchase? Base your calculations on straight- linedepreciation and a 50% income tax rate.

The Able Corporation is considering the installa-tion of a small electronic testing device for use inconjunction with a government contract the firmhas just won. The testing device will cost $20,000and will have an estimated salvage value of $5000in 5 years when the government contract is fin-ished. The firm will depreciate the instrument bythe sum-of-years-digits method, using 5 years asthe useful life and a $5000 salvage value. Assumethat Able pays 50% federal and state corporateincome taxes and uses 8%after-taxin economicanalysis. What minimum equal annual benefit mustAble obtainbefore taxesin each of the 5 yearsto justify purchasing the electronic testing device?

A house and lot are for sale for $155,000. It isestimated that $45,000 is the lands value and$110,000 is the value of the house. The net rentalincome would be $12,000 per year after taking allexpenses, except depreciation, into account. Thehouse would be depreciated by straight-line depre-ciation using a 27.5-year depreciable life and zerosalvage value.Mary Silva, the prospective purchaser, wantsa 10% after-tax rate of return on her investmentafter considering both annual income taxes and acapital gain when she sells the house and lot. Atwhat price would she have to sell the house at theend of 10 years to achieve her objective? You mayassume that Mary has an incremental income taxrate of 28% in each of the 10 years.

A corporation is considering buying a medium-sized computer that will eliminate a task that mustbe performed three shifts per day, 7 days perweek, except for one 8-hour shift per week whenthe operation is shut down for maintenance. Atpresent four people are needed to perform the dayand night tasks. Thus the computer will replacefour employees. Each employee costs the company$32,000 per year ($24,000 in direct wages plus$8000 per year in other company employee costs).It will cost$18,000 per year to maintain and operatethe computer.The computer will be depreciated bysum-of-years-digits depreciation using a 6-yeardepreciable life, at which time it will be assumed tohave zero salvage value. The corporation has a combined federal andstate incremental tax rate of 50%. If the firm wants a15% rate of return, after considering both state andfederal income taxes, how much can it afford to payfor the computer?

A sales engineer has the following alternatives toconsider in touring his sales territory.A.Buy a 2-year old used car for $14,500. Sal-vage value is expected to be about $5000 after3 more years.Maintenance and insurance cost is$1000 in the first yearand increasesat the rate of$500/year in subsequent years. Daily operatingexpenses are $50/day.B.Rent a similar car for $80/day.Based on a 12% after-tax rate of return, how manydays per year must he use the car to justify itspurchase? You may assume that this sales engineeris in the 28% incremental tax bracket. Use MACRSdepreciation.

A large profitable company, in the 40% combinedfederal/state tax bracket,is considering the purchaseof a new piece of equipment that will yield benefitsof $10,000 in Year 1, $15,000 in Year 2, $20,000 inYear 3, and $20,000 in Year 4. The equipment is tobe depreciated using 5-year MACRS depreciationstarting in the year of purchase (Year 0). It isexpected that the equipment will be sold at the endof Year 4 at 20% of its purchase price. What is themaximum equipment purchase price the companycan pay if its after-tax MARR is 10%?

A prosperous businessman is considering twoalternative investments in bonds. In both cases thefirst interestpaymentwouldbe receivedat theend ofthe first year. If his personal taxable income is fixedat $40,000 and he is single, which investment pro-duces the greater after-tax rate of return? Computethe after-tax rate of return for each bond to within1/4of 1 percent.Ann Arbor MunicipalBonds:A bond with a facevalue of $1000 pays $60 per annum. At the endof 15 years, the bond becomes due (matures),at which time the owner of the bond will receive$1000 plus the final $60 annual payment. Thebond may be purchased for $800. Since it is a municipal bond, the annual interest isnotsubject to federal income tax. The differencebetween what the businessman would pay forthe bond ($800) and the $1000 face value hewould receive at the end of 15 years must beincluded in taxable income when the $1000 isreceived.Southern Coal Corporation Bonds:Athousand-dollar bond yields $100 per year inannual interest payments. When the bondsmature at the end of 20 years, the bond-holder will receive $1000 plus the final $100interest. The bonds may be purchased nowfor $1000. The income from corporationbonds must be included in federal taxableincome.

You recently bought a mini-supercomputer for$10,000 to allow for tracking and analysis of real-time changes in stock and bond prices. Assume youplan on spendinghalf your time tending to the stockmarket with this computer and the other half as per-sonal use. Also assume you can depreciate yourcomputer by 20% per year over 5 years (straightline rate). How much tax savings will you have ineach of those 5 years, if any? Use a tax rate of 28%.

Use the after-tax IRR method to evaluate the fol-lowing three alternatives for MACRS 3-year prop- erty, and offer a recommendation. The after-taxMARR is 25%, the project life is 5 years, andthe firm has a combined incremental tax rateof 45%.FirstAnnual SalvageAlt. Cost Costs ValueA$14,000 $2500 $ 5,000B18,000 1000 10,000C10,000 50000

A small-business corporation is consideringwhether to replace some equipment in the plant.An analysis indicates there are five alternativesin addition to the do-nothing option, Alt.A.Thealternatives have a 5-year useful life with nosalvage value. Straight-line depreciation wouldbe used.Before- TaxUniformCost Annual BenefitsAlternatives (thousands) (thousands)A$0 $0B257.5C103D51.7E155F308.7The corporation has a combined federal and stateincome tax rate of 20%. If the corporation expectsa 10% after-tax rate of return for any new invest-ments, which alternative should be selected?

A corporation with $7 million in annual taxableincome is considering two alternatives:Before-Tax Cash Flow ($1000)Year Alt. 1Alt. 20$10,000$20,000110 4,5004,500112004,500Both alternatives will be depreciated bystraight-line depreciationassuminga 10-yeardepre-ciable life and no salvage value. Neither alternativeis to be replaced at the end of its useful life. Ifthe corporation has a minimum attractive rate ofreturn of 10%after taxes,which alternative shouldit choose? Solve the problem by:(a)Present worth analysis(b)Annual cash flow analysis(c)Rate of return analysis(d)Future worth analysis (e)Benefitcost ratio analysis

Two mutually exclusive alternatives are beingconsidered by a profitable corporation with anannual taxable income between $5 million and $10million.Before-Tax Cash Flow ($1,000)Year Alt.AAlt.B0$3000$50001 1000 10002 1000 12003 1000 14004 1000 26005 1000 2800Both alternatives have a 5-year useful anddepreciable life and no salvage value. AlternativeAwould be depreciated by sum-of-years-digitsdepreciation, and Alt.Bby straight-line depre-ciation. If the MARR is 10% after taxes, whichalternative should be selected?

A large profitable corporation is considering twomutually exclusive capital investments:Alt.AAlt.BInitial cost$11,000 $33,000Uniform annual benefit 3,000 9,000End-of-depreciable-life 2,000 3,000salvage valueDepreciation method SL SOYDEnd-of-useful-life 2,000 5,000salvage value obtainedDepreciable life, in years 3 4Useful life, in years5 5If the firms after-tax minimum attractive rateof return is 12% and its combined incrementalincome tax rate is 34%, which project should be selected?

A plant can be purchased for $1,000,000 or it canbe leased for $200,000 per year. The annual incomeis expected to be $800,000 with the annual operat-ing cost of $200,000. The resale value of the plantis estimated to be $400,000 at the end of its 10-yearlife. The companys combinedfederal andstateincome tax rate is 40%. A straight-line depreciationcan be used over the 10 years with the full first-yeardepreciation rate.(a)If the company uses the after-tax minimumattractive rate of return of 10%, should it leaseor purchase the plant?(b)What is the breakevenrate of return of purchaseversus lease?

VML Industries has need of specialized yarnmanufacturing equipment for operations over thenext 3 years. The firm could buy the machinery for$95,000 and depreciate it using MACRS. Annualmaintenance would be $7500, and it would havea salvage value of $25,000 after 3 years. Anotheralternative would be to lease the same machinefor $45,000 per year on an all costs inclusivelease (maintenance costs included in lease pay-ment). These lease payments are due at the begin-ning of each year. VML Industries uses an after-taxMARR of 18% and a combined tax rate of 40%.Do an after-tax present worth analysis to determinewhich option is preferred.

Padre Pio owns a small business and has taxableincome of $150,000. He is considering four mutu- ally exclusive alternative models of machinery.Which machine should be selected on an after- taxbasis? The after-tax MARR is 15%. Assume thateachmachineis MACRS 5-yearproperty andcan besold for a market value that is 25% of the purchasecost, and the project life is 10 years.Model I II III IVFirst cost $9000 $8000 $7500 $6200Annual costs 25 200 300 600

LoTech Welding can purchase a machine for$175,000 and depreciate it as 5-year MACRS prop-erty. Annual maintenance would be $9800, and itssalvage value after 8 years is $15,000. The machinecan also be leased for $35,000 per year on an allcosts inclusive lease (maintenance costs included).Lease payments are due at the beginning of eachyear, and they are tax-deductible. The firms com-bined tax rate for state and federal income taxes is40%.If the firms after-tax interest rate is 9%, whichalternative has the lower EAC and by how much?

For Problem 12-75, assume that Section 179 depre-ciation must be considered as this is LoTechs onlymajor equipment investment this year. Also assumethat the firm is profitable. How much lower is theannual cost of purchasing the machine?

For Problem 12-75, assume that the machine willbe financed with a 4-year loan whose interest rate is12%.(a)Graph the EAC for the purchase for financingfractions ranging from 0% to 100%.(b)Assume that 50% bonus depreciation is alsoavailable. Graph the EAC for the purchase forfinancing fractions ranging from 0% to 100%.(c)Assume that Section 179 depreciation mustbe considered, as this is LoTechs only majorequipment investment this year. Also assumethat the firm is profitable.Graph the EACfor thepurchase for financing fractions ranging from0% to 100%