Locus Dominico, Company., a highly profitable maker of customized boats, is planning to introduce a new model shortly. The firm must purchase equipment immediately at a cost of Sh.900,000. Freight and installation costs for this equipment will be Sh.100,000. The equipment will be depreciated as a 5-year class asset under income tax act(straight line depreciation method). During the first year, Locus will have incremental operating expenses of Sh.300,000 that are attributable to this project. Locus expects to be able to sell 1,000 boats during year 2 at an average price of Sh.800 each and to incur operating expenses of Sh.300,000. Also, Locus expects its net working capital investment will increase by Sh.50,000 during year 2. (Assume all operating costs and revenues are incurred at the end of each year.) The marginal tax rate for Locus is 40 percent. Required: What is the required net investment, and what are the year 1 and year 2 net cash flows?
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
Locus Dominico, Company., a highly profitable maker of customized boats, is
planning to introduce a new model shortly. The firm must purchase equipment
immediately at a cost of Sh.900,000. Freight and installation costs for this equipment will
be Sh.100,000. The equipment will be
tax act(straight line depreciation method). During the first year, Locus will have
incremental operating expenses of Sh.300,000 that are attributable to this project. Locus
expects to be able to sell 1,000 boats during year 2 at an average price of Sh.800 each and
to incur operating expenses of Sh.300,000. Also, Locus expects its net working capital
investment will increase by Sh.50,000 during year 2. (Assume all operating costs and
revenues are incurred at the end of each year.) The marginal tax rate for Locus is 40
percent.
Required:
What is the required net investment, and what are the year 1 and year 2 net cash flows?
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