A company makes an investment of $150,000 with a useful life of 10 years (no salvage value) and expects to use this investment to generate $300,000 in sales with $280,000 in incremental operating costs. If the company operates in an environment with a 30% tax rate, what are the expected after-tax cash flows that the company will use to evaluate the capital investment decision?
a. $9,500
b. $16,500
c. $18,500
d. $10,500
Explanation
Choice “c” is correct.
In the explanation (which I can't post because its in an odd format), the Becker people are saying that in addition to the 14000 in after tax direct cash flows, you must divide the total investment of 150,000 by 10 to get a 15000 dollar depreciation tax shield and then multiply that number by the tax rate.
My issue with this is that with respect to the sales and the variable costs, we are looking at this investment from the entire, cumulative perspective of the life of the project. the total profit we expect from the project is 20,000 correct? well if we are looking at the direct cash flows from the perspective of the life of the project, then why aren't we looking at depreciation the same way?
if the question states (no salvage value) then we should assume full depreciation, meaning through the entire life of the investment, there will be a total depreciation tax shield of $150000. shouldn't we be taking the entire 150,000 and multiplying it by the tax rate to find the total after-tax tax shield affect on the total life of the investment, just like we did with the direct cash flows?
Any thoughts would be helpful.
FAR: PASSED
REG: PASSED
AUD: PASSED
BEC: PASSED
DONE
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