Question

"The Simon Machine Tools Company is considering purchasing a new set of machine tools to process special orders. The following financial information is available.
- Without the project, the company expects to have a taxable income of $441,000 each year from its regular business over the next three years.
- With the three-year project, the purchase of a new set of machine tools at a cost of $54,000 is required. The equipment falls into the MACRS three-year class. The tools will be sold for $11,000 at the end of project life. The project will be bringing in additional annual revenue of $72,000, but it is expected to incur additional annual operation of $22,000.
What are the additional income taxes paid because of the project in year 2 if the tax rate is 34%?"

Answer 1

Working notes: In year 2,

(1) Annual depreciation = $54,000 x 27.78%** = $15,001

(2) Before-tax income ($) = Annual revenue - Depreciation - Operating cost = 72,000 - 15,001 - 22,000 = 34,999

(3) After-tax income ($) = Before-tax income x (1- tax rate) = 34,999 x (1 - 0.34) = 34,999 x 0.66 = 23,099

(4) Assuming uniform annual revenue and costs without project, Taxable income in year 2 = $441,000/3 = $147,000

(5) After-tax income without the project ($) = 147,000 x (1 - 0.34) = 147,000 x 0.66 = 97,020

Therefore,

Additional income tax paid in year 2 = $(97,020 - 23,099) = $73,921