Question

The Gabriel Co. is considering a 7-year project that would require a cash outlay of $140,000 for machinery and an additional $30,000 for working capital that would be released at the end of the project. The equipment would be depreciated evenly over the 7 years and have a salvage value of $ 7,000 at the end of 7 years. The project would generate before tax annual cash inflows of $41,500. The tax rate is 20% and the company's discount rate is 12%.

1. What is the annual accounting income?
2. What is the annual after-tax cash flow?
3. What is the payback based upon the initial cash outflows?
4. What is the discounted payback based upon the initial cash outflows?
5. What is the simple rate of return based upon the initial cash outflows?
6. What is the net present value?
7. What is the internal rate of return?
8. Would you recommend this project or not? Why?

Answer 1

1. What is the annual accounting income?

Particular	Amount
Before tax annual cash inflows	41,500
Less: Depreciation [(140,000-7,000)/7]	(19,000)
Earnings before tax	22,500
Less: Tax expense (22,500 X 20%)	(4,500)
Earnings after tax / Accounting Income	18,000

2. What is the annual after-tax cash flow?

Particular	Amount
Earnings after tax	18,000
Add: Depreciation	19,000
After tax cash flow	37,000

3. What is the payback based upon the initial cash outflows?

Payback Period = Initial Invetment / Annual Cash Inflows

= 140000 / 37000

= 3.78 Years