Question

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%).

Answer #1

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 |

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