Erik Sorensen

EGR 282 Engineering Economics

11 May 2012

Page,1

Chapter 12 Quiz
To Find: PARC, a large profitable firm, has an opportunity to expand one of its production facilities at a cost of
$375,000. The equipment is expected to have a useful life of 10 years and to have a resale value of $25,000 after 10
years of use. If the expansion is undertaken, PARC expects that their income will increase by $60,000 for year 1, and
then increase by $5000 each year through year 10 ($65,000 for year 2, $70,000 for year 3, ..., $105,000 for year 10). If
the equipment is purchased, PARC will depreciate it using a 7 year class life and MACRS depreciation. PARC will receive a 10% investment tax credit if the equipment is purchased.
The annual operating cost for the expansion is expected to be $5,000 for the first year and to increase by 5% per year
($5250 for year 2, $5512.50 for year 3, ..., $7756.64 for year 10). If the equipment is purchased, PARC will pay
$175,000 down and finance the balance with a 5-year 12% loan payable in annual payments. Since PARC is a "large
and profitable" firm their tax rate is 46% and their ordinary gains are taxed at a rate of 28%.
What is the After Tax Rate of Return for PARC? Given the current economy, would you suggest PARC do the expansion?
Solution:
$375,000
10
$25,000
7
10%
$175,000
$200,000
12%
5
46%
28%
IRR

First cost
Life
Salvage
MACRS Depreciation
Tax Credit
Down Payment
Balance to be Financed
Finance Rate
Loan term, years
Tax rate
"Ordinary Gains" Rate
To find

Year
0
1
2
3
4
5
6
7
8
9
10
Year
0
1
2
3
4
5
6
7
8
9
10

Income Schedule
$
$
$
$
$
$
$
$
$
$

Untaxed BTCF
$ (175,000.00)

25,000.00

60,000.00
65,000.00
70,000.00
75,000.00
80,000.00
85,000.00
90,000.00
95,000.00
100,000.00
105,000.00
Taxed BTCF
$
(481.95)
$
4,268.05
$
9,005.55
$ 13,729.93
$ 18,440.52
$ 78,618.59
$ 83,299.52
$ 87,964.50
$ 92,612.72
$ 97,243.36
Cum. Deprec. =

Costs Schedule
$ (175,000.00)
$
(5,000.00)
$
(5,250.00)
$
(5,512.50)
$
(5,788.13)
$
(6,077.53)
$
(6,381.41)
$
(6,700.48)
$
(7,035.50)
$
(7,387.28)
$
(7,756.64)
Salvage - Book
Value

MACRS
$53,571.43
$91,836.73
$65,597.67
$46,855.48
$33,468.20
$33,468.20
$33,468.20
$16,734.10

$ 25,000.00

Finance
$
$
$
$
$

Net Cash Flow

$ (175,000.00)
$
(481.95)
$
4,268.05
$
9,005.55
$ 13,729.93
$ 18,440.52
$ 78,618.59
$ 83,299.52
$ 87,964.50
$ 92,612.72
$ 97,243.36

(55,481.95)
(55,481.95)
(55,481.95)
(55,481.95)
(55,481.95)

Taxed Income
$
$ (54,053.37)
$ (87,568.68)
$ (56,592.11)
$ (33,125.55)
$ (15,027.68)
$ 45,150.39
$ 49,831.32
$ 71,230.40
$ 92,612.72
$ 97,243.36

$
$
$
$
$
$
$
$
$
$
$

Tax
17,500.00
24,864.55
40,281.59
26,032.37
15,237.75
6,912.73
(20,769.18)
(22,922.41)
(32,765.98)
(42,601.85)
(51,731.95)

$ 375,000.00

With an ATRoR of 21.32%, this project should

definitely be pursued

ATCF
$ (157,500.00)
$ 24,382.61
$ 44,549.65
$ 35,037.93
$ 28,967.68
$ 25,353.25
$ 57,849.41
$ 60,377.11
$ 55,198.51
$ 50,010.87
$ 70,511.41
21.32%