Suppose an asset has a first cost of $8,000,a life of five years, a salvage value of $2,000 atthe end of five years, and a net annual before-taxrevenue of $2,500. The firm’s marginal tax rate is35%. The asset will be depreciated by three-yearMACRS.(a) Using the generalized cash flow approach, determine the cash flow after taxes.(b) Rework part (a), assuming that the entire investment would be financed by a bank loan at aninterest rate of 9%.(c) Given a choice between the financing methodsof parts (a) and (b), show calculations to justifyyour choice of which is the better one at an interest rate of 9%.
Suppose an asset has a first cost of $8,000,a life of five years, a salvage value of $2,000 atthe end of five years, and a net annual before-taxrevenue of $2,500. The firm’s marginal tax rate is35%. The asset will be depreciated by three-yearMACRS.(a) Using the generalized cash flow approach, determine the cash flow after taxes.(b) Rework part (a), assuming that the entire investment would be financed by a bank loan at aninterest rate of 9%.(c) Given a choice between the financing methodsof parts (a) and (b), show calculations to justifyyour choice of which is the better one at an interest rate of 9%.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Suppose an asset has a first cost of $8,000,
a life of five years, a salvage value of $2,000 at
the end of five years, and a net annual before-tax
revenue of $2,500. The firm’s marginal tax rate is
35%. The asset will be depreciated by three-year
MACRS.
(a) Using the generalized
(b) Rework part (a), assuming that the entire investment would be financed by a bank loan at an
interest rate of 9%.
(c) Given a choice between the financing methods
of parts (a) and (b), show calculations to justify
your choice of which is the better one at an interest rate of 9%.
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