2024 – 11 5 Tax Rate Suppose that LilyMac Photography expects EBIT to be approximately 200 000 per year for the foreseeable future

11-5. Tax Rate Suppose that LilyMac Photography expects EBIT to be approximately $200,000

per year for the foreseeable future, and that it has 1,000 10-year, 9 percent annual coupon

bonds outstanding. What would the appropriate tax rate be for use in the calculation of

the debt component of LilyMac’s WACC?

12-1. After-Tax Cash Flow from Sale of Assets Suppose you sell a fixed asset for $109,000 when its book value is $129,000. If your company’s marginal tax rate is 39 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

12-3 EAC Approach You are trying to pick the least-expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $14,000 to purchase and which will have OCF of 2 $1,200 annually throughout the vehicle’s expected life of three years as a delivery vehicle; and the Toyota Prius, which will cost $20,000 to purchase and which will have OCF of 2 $650 annually throughout that vehicle’s expected 4-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 12 percent, which one should you choose?

12-5 EAC Approach You are considering the purchase of one of two machines used in your

manufacturing plant. Machine A has a life of two years, costs $80 initially, and then $125

per year in maintenance costs. Machine B costs $150 initially, has a life of three years, and

requires $100 in annual maintenance costs. Either machine must be replaced at the end of

its life with an equivalent machine. Which is the better machine for the firm? The discount

rate is 12 percent and the tax rate is zero.

12-6 Project Cash Flows KADS Inc. has spent $400,000 on research to develop a new computer

game. The firm is planning to spend $200,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total

$50,000. The machine has an expected life of three years, a $75,000 estimated resale value,

and falls under the MACRS 7-year class life. Revenue from the new game is expected to be

$600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 35 percent, an

opportunity cost of capital of 15 percent, and it expects net working capital to increase by

$100,000 at the beginning of the project. What will the cash flows for this project be?

12-13 Project Cash Flows Mom’s Cookies Inc. is considering the purchase of a new cookie

oven. The original cost of the old oven was $30,000; it is now five years old, and it has a

current market value of $13,333.33. The old oven is being depreciated over a 10-year life

toward a zero estimated salvage value on a straight-line basis, resulting in a current book

value of $15,000 and an annual depreciation expense of $3,000. The old oven can be used

for six more years but has no market value after its depreciable life is over. Management

is contemplating the purchase of a new oven whose cost is $25,000 and whose estimated

salvage value is zero. Expected before-tax cash savings from the new oven are $4,000 a

year over its full MACRS depreciable life. Depreciation is computed using MACRS over a

5-year life, and the cost of capital is 10 percent. Assume a 40 percent tax rate. What will the

cash flows for this project be?