Unformatted text preview: MGMT 201 (Ganguly) MGMT
Lecture 19: End Chapter 16 and Lecture tie up loose ends tie Recall the effect of Income Recall Taxes Taxes $50,000 × 28% = $14,000 2 Recall the effect of Income Recall Taxes Taxes A short cut works like this: Increase in income × ( 1  tax rate) $50,000 × ( 1  .28) = $36,000
3 Modified Accelerated Cost Modified Recovery System (MACRS) Recovery
Tax depreciation is usually computed using Tax MACRS. Here are the depreciation rate for 3, 5, and 7year class life assets. 3, 4 Modified Accelerated Cost Modified Recovery System (MACRS) Recovery
A company is considering the purchase of a company machine that will increase aftertax cash flows by $20,000 over the next five years. The five machine is depreciated using MACRS and the company uses a 10% discount rate to compute all present values. The machine will cost $100,000 and the company is subject to a 28% tax rate. 28% Let’s calculate the net present value of the Let’s proposal. proposal.
5 Modified Accelerated Cost Modified Recovery System (MACRS) Recovery
Calculation of the present value of the Calculation depreciation tax shield. depreciation $5,600 × (1.10)^ or = $5,600 x 0.909 $20,000 × 28% $100,000 × 20% 6 Modified Accelerated Cost Modified Recovery System (MACRS) Recovery
Calculation of the present value proposal Calculation cash flows. cash
$20,000 × (1.10)^1 7 Modified Accelerated Cost Modified Recovery System (MACRS) Recovery
Net present value of the proposal.
The present value of the proposal is less than the cost of the equipment ($100,000). The proposal has a negative net present value. Ding! You could also have included the cost
explicitly in the calculation with a PV factor =1
8 Recall, about Working Capital
Some investment proposals require Some additional outlays for working capital such as increases in cash, accounts receivable, and inventory. and 9 Extended Illustration
Let take a close look at a present value Let analysis for an investment decision facing James Company. facing James Company 10 10 Extended Illustration
James Company has been offered a fiveyear contract James to provide component parts for a large manufacturer. manufacturer. 11 11 Extended Illustration
At the end of five years the working capital At will be released and may be used elsewhere by James. elsewhere James Company uses a discount rate of James 10%. 10%. James uses straightline depreciation. All items are taxed at 30%. Should the contract be accepted?
12 12 Extended Illustration
Annual accounting income from operations Annual from Remember depreciation is a noncash expense that provides a tax shield. 13 13 Extended Illustration
Annual cash inflows from operations Annual from Remember depreciation is a noncash expense that provides a tax shield. 14 14 Extended Illustration The relining is considered normal maintenance The and will reduce income in year 3. Because the cost is tax deductible, income will be lower by $21,000 ($30,000 × 1 tax rate). $21,000 15 15 Extended Illustration Because the salvage value of the equipment will equal Because the book value (cost less accumulated depreciation), there will be no taxable gain or loss. there
16 16 Extended Illustration 17 17 Extended Illustration Present value of $1 factor for 3 years at 10%. 18 18 Extended Illustration Present value of $1 factor for 5 years at 10%. 19 19 Extended Illustration We should accept the contract because the present value of the cash inflows exceeds the present value of the cash outflows by $89,981. The project has a of $89,981 The positive net present value. positive net
20 20 Extended Illustration
General decision rule . . . 21 21 We can invest in either of these projects. We Use a 10% discount rate to determine the net present value of the cash flows. the
Project A Immediate cash outlay $ 100,000 Cash inflows: Year 1 $ 50,000 Year 2 40,000 Year 3 30,000 Total inflows $ 120,000 Project B $ 100,000 $ 30,000 40,000 50,000 $ 120,000
22 22 Similarlooking Investment Projects! Projects! We can invest in either of these projects. Use a 10% discount rate to determine The total cash flows are the same, the net present value of the cash flows. butthe pattern of the flows is the
Project A Immediate cash outlay $ 100,000 Cash inflows: Year 1 $ 50,000 Year 2 40,000 Year 3 30,000 Total inflows $ 120,000 Similarlooking Investment Similarlooking Projects! Projects! different. Project B $ 100,000 $ 30,000 40,000 50,000 $ 120,000
23 23 Similarlooking Investment Similarlooking Projects! Projects!
Let’s calculate the present value of the cash Let’s flows associated with Project A. Project 24 24 Similarlooking Investment Similarlooking Projects! Projects!
Let’s calculate the present value of the cash Let’s flows associated with Project A. Project (1.10) = 0.909 rounded
25 25 1 Similarlooking Investment Similarlooking Projects! Projects!
Let’s calculate the present value of the cash Let’s flows associated with Project A. Project (1.10) = 0.826 rounded
26 26 2 Similarlooking Investment Similarlooking Projects! Projects!
Let’s calculate the present value of the cash Let’s flows associated with Project A. Project This project has a positive net present value which means This the project’s return is greater than the discount rate. the
27 27 Similarlooking Investment Similarlooking Projects! Projects!
Here is the net present value of the cash Here flows associated with Project B. Project
Immediate cash outlay Cash inflows: Year 1 Year 2 Year 3 Net present value Project B $(100,000) $ 30,000 40,000 50,000 PV Factor 1.000 0.909 0.826 0.751 PV $(100,000) 27,270 33,040 37,550 $ (2,140) Project B has a negative net present value which means the project’s return is less than the discount rate. the
28 28 End of Chapter 16 – at last!
Practice Practice Practice Now do the above three things! 29 29 ...
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 Spring '08
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 Depreciation, Net Present Value

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