Question

# The characteristics of the proposed purchase plan of a new piece of equipment are as following:...

The characteristics of the proposed purchase plan of a new piece of equipment are as following:

Initial capital cost = HK\$ 5000

Useful life = 5 years

Salvage value = 0

Expected annual income = 6000 - 100 j (j = 1, 2, 3, 4, 5 years)

Expected annual disbursements = 950 + 50 j

Effective tax rate = 20%

(1)Tabulate the cash flows after tax if the effective tax rate is 20% and the straight line depreciation method is used.

(2)If the "Double-Declining-Balance Method" and the "Sum-of-Years'-Digits Method" are used for the calculation of the depreciation, please tabulate the cash flows before tax, the annual depreciation, the annual tax, and the cash flows after tax. And compare the accumulated depreciations in the end of the 5th year between these two methods.

(3)Please investigate and comment that how the "effective tax rate" and its variation will affect the results of the above questions. For example, the "effective tax rate" varies +/- 0~0.05 based on the original 0.20 (i.e. the effective tax rate varies in the range between 15%~25%).

 Year--St'line depn 0 1 2 3 4 5 1.Initial capital cost -5000 2.Expected annual income 6000 5900 5800 5700 5600 3.Expected annual disburs. -950 -1000 -1050 -1100 -1150 4.St.line dpen. -1000 -1000 -1000 -1000 -1000 5.EBIT(2+3+4) 4050 3900 3750 3600 3450 6. Tax at 20% -810 -780 -750 -720 -690 7. NOPAT(5+6) 3240 3120 3000 2880 2760 8.Add back:depn. 1000 1000 1000 1000 1000 9.Operating cash flow 4240 4120 4000 3880 3760
 DDB method of depn. Year 0 1 2 3 4 5 1.Initial capital cost -5000 2.Expected annual income 6000 5900 5800 5700 5600 3.Expected annual disburs. -950 -1000 -1050 -1100 -1150 4.DDB dpen. -2000 -1200 -720 -432 -259 5.EBIT(2+3+4) 3050 3700 4030 4168 4191 6. Tax at 20% -610 -740 -806 -833.6 -838.2 7. NOPAT(5+6) 2440 2960 3224 3334.4 3352.8 8.Add back:depn. 2000 1200 720 432 259 9.Operating cash flow 4440 4160 3944 3766 3612
 Sum of the Years digits method of depn. Year 0 1 2 3 4 5 1.Initial capital cost -5000 2.Expected annual income 6000 5900 5800 5700 5600 3.Expected annual disburs. -950 -1000 -1050 -1100 -1150 4.SOYD dpen. -1667 -1333 -1000 -667 -333 5.EBIT(2+3+4) 3383 3567 3750 3933 4117 6. Tax at 20% -676.6 -713.4 -750 -786.6 -823.4 7. NOPAT(5+6) 2706.4 2853.6 3000 3146.4 3293.6 8.Add back:depn. 1667 1333 1000 667 333 9.Operating cash flow 4373 4187 4000 3813 3627
 DDB rate = St.line rate *2= 1/5*2= 40% on declining balance Depn. Base digits= 1+2+3+4+5=15 Year BV*40% Acc. Depn. BV Year Depreciation Acc. Depn. BV 0 5000 0 5000 1 2000 2000 3000 1 5/15*5000= 1666.67 3333.33 2 1200 3200 1800 2 4/15*5000= 3000.00 2000.00 3 720 3920 1080 3 3/15*5000= 4000.00 1000.00 4 432 4352 648 4 2/15*5000= 4666.67 333.33 5 259 4611 389 5 1/15*5000= 5000 0.00 Acc. Depn.= 4611 Acc. Depn.= 5000

Effect of tax 15% & 25%

cash flow decreases with increase in Tax rate (25%)& increases when tax rate decrease.(15%)

 tax at 20% OCF-St.line 4240 4120 4000 3880 3760 OCF-DDB 4440 4160 3944 3766.4 3611.8 OCF-SOYD 4373 4187 4000 3813 3627 Tax a t15% OCF-St.line 4443 4315 4188 4060 3933 OCF-DDB 4593 4345 4146 3975 3821 OCF-SOYD 4543 4365 4188 4010 3832 Tax at 25% 4038 3925 3813 3700 3588 OCF-St.line 4288 3975 3743 3558 3402 OCF-DDB 4204 4008 3813 3617 3421 OCF-SOYD