Question

Green House Tomato Company is considering the purchase of new processing equipment for $1,500,000, with an additional installation cost of $18,000. The new equipment will result in earnings before interest and taxes of $450,000 per year, and to operate the equipment properly, workers would have to go through an initial training session costing the company $50,000. In addition, because the equipment is extremely efficient, its purchase necessitates an increase in inventory of $90,000. Assume the company uses straight-line depreciation, the equipment has an expected life of seven years, the equipment will have no salvage value, the marginal tax rate is 28 percent, and the company has a required rate of return of 12 percent.

What is the initial outlay (year 0) associated with the equipment?

What are the annual after-tax cash flows associated with the equipment for years one through six?

Answer 1

Answer :

Calculation of Initial Outflow at year 0

Initial Outflow = Purchase Cost + Installation Cost + Increase in Inventory

= (1,500,000 + 18,000) + 90,000

= 1,608,000

Note : Initial Training session cost will not be considered .

Calculation of Annual After Tax cash Flows from year 1 - 6

Annual After Tax Cash Flows = [Earning Before Tax * ( 1 - Tax rate) ] + [Depreciation * Tax rate]

= [450000 * (1 - 0.28)] + [(1,518,000 / 7) * 0.28]

= 324000 + 60719.99

= 384719.99 or 384720