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The shell Corp. owns a piece of petroleum drilling equipment that costs &100,000 and will be...

The shell Corp. owns a piece of petroleum drilling equipment that costs &100,000 and will be depreciated by Straight-line depreciation with B=$100,000, N=5 years, S=$0. There is a combined 40% tax rate. Shell will lease the equipment to others each year and receive $50,000 per year.  At the end of 3 years, the firm will sell the equipment for $30,000. If the firm requires a 10% after-tax rate of return, what is the PW of the investment?

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Answer #1

Ans:

Initial Outflow : $100,000

Annual Inflow : $50,000

Tax Rate : 40%

After Tax Inflow : $50,000 * 60% = $30,000

Annual Depreciation : $100,000/5 = $20,000

Depreciation Tax Savings : $20,000 * 40% = $8,000

Net after tax annual Inflows : $30,000 + $8,000 = $38,000

Sale value after 3 Years : $30,000

Book Value after 3 Years = $100,000 - $20,000*3 = $40,000

Loss on sale of asset = $30,000 - $40,000 = $10,000

Tax Savings on loss : $10,000 * 40% = $4,000

Net after tax benefits on sale after 3 years : $30,000 + $4,000 = $34,000

Interest Rate : 10%

Annuity factor @10% for 3 years : 2.486852

PV factor @10% for 3 years : 0.751315

Present value of Inflows : $38,000 * 2.486852 + $34,000 * 0.751315 = $120,045

PW of Investment = $120,045 - $100,000 = $20,045

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