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The Shellout Corp. owns a piece of petroleum drilling equipment that costs $100,000 and will be depreciated over 10 years by double declining balance depreciation. There is a combined 40% tax rate. Shellout will lease the equipment to others and each year receive $30,000 in rent. At the end of 5 years, the firm will sell the equipment for $35,000. What is the after-tax rate of return Shellout will receive from this equipment investment?

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Kritika Krishnakumar
Kritika KrishnakumarLv10
28 Sep 2019

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The Capitalpoor Company is considering purchasing business machine for $100,000. An alternative is to rent it for $35,000 at the beginning of each year. The rental would include all repairs and services. If the machine is purchased, a comparable repair and service contract can be obtained for $1,000 per year.The salesperson of the business machine firm has indicated that the expected useful service life of the machine is five years, with zero market value, but the company is not sure how long the machine will actually be needed. If the machine is rented, the company can cancel the lease at the end of any year. Assuming an income tax rate of 25%, a straight-line depreciation charge of $20,000 for each year the machine is kept, and an after-tax MARR of 10%, prepare an appropriate analysis to help the firm decide whether it is more desirable to purchase or rent.

After-Tax Net Present Value and IRR (Non-MACRS Rules) eEgg is considering the purchase of a new distributed network computer system to help handle its warehouse inventories. The system costs $60,000 to purchase and install and $30,000 to operate each year. The system is estimated to be useful for four years. Management expects the new system to reduce by $62,000 a year the cost of managing inventories. The firm’s cost of capital is 10%.

Required
1. What is the net present value (NPV) of the proposed investment under each of the following independent situations?
a. The firm is not yet profitable and pays no taxes.
b. The firm is in the 30% income tax bracket and uses straight-line depreciation with no salvage value. Assume MACRS rules do not apply.
c. The firm is in the 30% income tax bracket and uses double-declining-balance depreciation with no salvage value. Assume MACRS rules do not apply.

2. What is the internal rate of return (IRR) of the proposed investment for situations 1(a) and 1(b) above?

***Please explain the math used to calculate the answers.***

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