Old Machine Sold at a Gain

3
. Regal Industries is replacing a
grinder purchased 5 years ago for
$15,000 with a new one
costing $25,000 cash. The original
grinder is being depreciated on a
straight-line basis over
15 years to a zero salvage value.
Regal will sell this old equipment
to a third party for $6,000
cash. The new equipment will be
depreciated on a straight-line basis
over 10 years to a zero
salvage value. Assuming a 40%
marginal tax rate, Regal’s net cash
investment at the time of
purchase if the old grinder is sold
and the new one is purchased is
a. $19,000 c. $17,400
b. $15,000 d. $25,000 CMA 1292
4-9
4
. A machine that cost $50,000 and
is fully depreciated is sold for
$10,000. The $10,000 is then
used as a down payment on the
purchase of a new machine costing
$75,000. Assuming a
40% tax rate, the out-of-pocket
cost of the new machine is:
A. $75,000 C. $65,000
B. $71,000 D. $69,000 C & U
Old Equipment Sold at a Loss
*. In making a decision to invest in
a project the cash flow should be
adjusted for their tax effect.
Assume an income tax rate of 35%
an old machine with a book value
of P70,000 will be
replaced by a new machine costing
P150,000. The market value of
the old machine is
P50,000. The after tax investment
outlay is (E)
a. P82,500 c. P107,000
b. P93,000 d. P135,000 RPCPA
1085
*. In deciding the investment in a
project, cash flows should be
adjusted for their tax effect.
Assume an income tax rate of
35%. An old equipment with a
book value of P15,000 will be
replaced by a new equipment
costing P50,000. The market
value of the old equipment is
P11,000. The after-tax investment
outlay is (E)
a. P34,400 c. P39,000
b. P37,600 d. P40,400 RPCPA
0581
Old Equipment Sold at a Loss,
Additional Working Capital
*. Diliman Republic Publishers,
Inc. is considering replacing an old
press that cost P800,000 six
years ago with a new one that
would cost P2,250,000. Shipping
and installation would cost an
additional P200,000. The old
press has a book value of P150,000
and could be sold currently
for P50,000. The increased
production of the new press
would increase inventories by
P40,000, accounts receivable by
P160,000 and accounts payable
by P140,000. Diliman
Republic’s net initial investment
for analyzing the acquisition of the
new press assuming a 35%
income tax rate would be (D)
a. P2,450,000 c. P2,600,000
b. P2,425,000 d. P2,250,000
RPCPA 0595
44. Superstrut is considering
replacing an old press that cost
$80,000 six years ago with a new
one that would cost $245,000. The
old press has a net book value of
$15,000 and could be
sold for $5,000. The increased
production of the new press would
require an investment in
additional working capital of
$6,000. The company's tax
rate is 40%. Superstrut's net
investment now in the project
would be: (M)
a. $256,000. c. $250,000.
b. $242,000. d. $245,000. CMA
adapted
Old Machine Sold at a Loss, Cash
Cost Savings on New Machine
5
. A company is considering
replacing existing 2-year-old
equipment. This project will
require a
discounted cash flow analysis to
determine if the benefits exceed
the costs. Year-end data
regarding the existing and new
equipment are shown below.
Existing Equipment New
Equipment
Original cost $600,000 $540,000
Useful life (in years) 5 3
Remaining life (in years) 3 3
Annual depreciation $120,000
$180,000
Accumulated depreciation
$240,000 N/A*
Book value $360,000 N/A*
Current cash disposal value
$100,000 N/A*
* Value is not applicable here.
The new equipment will result in
cash operating cost savings of
$150,000 annually, before
taxes. The new equipment would
be purchased late in the current
year to be operational at the
beginning of the first year of the
project. The existing equipment
would be sold early in the first
year of the project, meaning no
further depreciation would be
taken on it. The company has a
Old Machine Sold at a Gain
3
. Regal Industries is replacing a
grinder purchased 5 years ago for
$15,000 with a new one
costing $25,000 cash. The original
grinder is being depreciated on a
straight-line basis over
15 years to a zero salvage value.
Regal will sell this old equipment
to a third party for $6,000
cash. The new equipment will be
depreciated on a straight-line basis
over 10 years to a zero
salvage value. Assuming a 40%
marginal tax rate, Regal’s net cash
investment at the time of
purchase if the old grinder is sold
and the new one is purchased is
a. $19,000 c. $17,400
b. $15,000 d. $25,000 CMA 1292
4-9
4
. A machine that cost $50,000 and
is fully depreciated is sold for
$10,000. The $10,000 is then
used as a down payment on the
purchase of a new machine costing
$75,000. Assuming a
40% tax rate, the out-of-pocket
cost of the new machine is:
A. $75,000 C. $65,000
B. $71,000 D. $69,000 C & U
Old Equipment Sold at a Loss
*. In making a decision to invest in
a project the cash flow should be
adjusted for their tax effect.
Assume an income tax rate of 35%
an old machine with a book value
of P70,000 will be
replaced by a new machine costing
P150,000. The market value of
the old machine is
P50,000. The after tax investment
outlay is (E)
a. P82,500 c. P107,000
b. P93,000 d. P135,000 RPCPA
1085
*. In deciding the investment in a
project, cash flows should be
adjusted for their tax effect.
Assume an income tax rate of
35%. An old equipment with a
book value of P15,000 will be
replaced by a new equipment
costing P50,000. The market
value of the old equipment is
P11,000. The after-tax investment
outlay is (E)
a. P34,400 c. P39,000
b. P37,600 d. P40,400 RPCPA
0581
Old Equipment Sold at a Loss,
Additional Working Capital
*. Diliman Republic Publishers,
Inc. is considering replacing an old
press that cost P800,000 six
years ago with a new one that
would cost P2,250,000. Shipping
and installation would cost an
additional P200,000. The old
press has a book value of P150,000
and could be sold currently
for P50,000. The increased
production of the new press
would increase inventories by
P40,000, accounts receivable by
P160,000 and accounts payable
by P140,000. Diliman
Republic’s net initial investment
for analyzing the acquisition of the
new press assuming a 35%
income tax rate would be (D)
a. P2,450,000 c. P2,600,000
b. P2,425,000 d. P2,250,000
RPCPA 0595
44. Superstrut is considering
replacing an old press that cost
$80,000 six years ago with a new
one that would cost $245,000. The
old press has a net book value of
$15,000 and could be
sold for $5,000. The increased
production of the new press would
require an investment in
additional working capital of
$6,000. The company's tax
rate is 40%. Superstrut's net
investment now in the project
would be: (M)
a. $256,000. c. $250,000.
b. $242,000. d. $245,000. CMA
adapted
Old Machine Sold at a Loss, Cash
Cost Savings on New Machine
5
. A company is considering
replacing existing 2-year-old
equipment. This project will
require a
discounted cash flow analysis to
determine if the benefits exceed
the costs. Year-end data
regarding the existing and new
equipment are shown below.
Existing Equipment New
Equipment
Original cost $600,000 $540,000
Useful life (in years) 5 3
Remaining life (in years) 3 3
Annual depreciation $120,000
$180,000
Accumulated depreciation
$240,000 N/A*
Book value $360,000 N/A*
Current cash disposal value
$100,000 N/A*
* Value is not applicable here.
The new equipment will result in
cash operating cost savings of
$150,000 annually, before
taxes. The new equipment would
be purchased late in the current
year to be operational at the
beginning of the first year of the
project. The existing equipment
would be sold early in the first
year of the project, meaning no
further depreciation would be
taken on it. The company has a
B Company is considering two alternative ways to depreciate a proposed investment. The investment has
an initial cost of $100,000 and an expected five-year life. The two alternative depreciation schedules follow:
Method 1 Method 2

Year 1 depreciation $20,000 $40,000

Year 2 depreciation $20,000 $30,000
Year 3 depreciation $20,000 $20,000
Year 4 depreciation $20,000 $10,000
Year 5 depreciation $20,000 $0
 Assuming that the company faces a marginal tax rate of 40 percent and has a cost of capital of 10 percent, what
is the difference between the two methods in the present value of the depreciation tax benefit?
a. $7,196 c. $2,878
b. $0 d. $6,342 Barfield

Present Value of 1 & Annuity of 1 Computation

Present Value of Salvage Value & Annual Net Cash Inflow
Questions 1 and 2 are based on the following information. H&M

The following information pertains to an investment:

Investment $70,000
Annual revenues $48,000
Annual variable costs $16,000
Annual fixed out-of-pocket costs $10,000
Salvage value $ 6,000
Discount rate 12%
Expected life of project 8 years

i
. Ignore income taxes. The present value of the salvage value is (rounded)
a. $2,424 c. $3,114
b. $2,869 d. $3,224

ii
. Ignore income taxes. The present value of the annual net cash inflows from operations is (rounded)
a. $68,411 c. $102,442
b. $76,269 d. $109,296

Comprehensive
Questions 7 through 9 are based on the following information. CMA 1295 4-3 to 5

The Moore Corporation is considering the acquisition of a new machine. The machine can be purchased
for $90,000, it will cost $6,000 to transport to Moore’s plant and $9,000 to install. It is estimated that
the machine will last 10 years, and it is expected to have an estimated salvage value of $5,000. Over its
10-year life, the machine is expected to produce 2,000 units per year with a selling price of $500 and
combined materials and labor costs of $450 per unit. Federal tax regulations permit machines of this
type to be depreciated using the straight-line method over 5 years with no estimated salvage value.
Moore has a marginal tax rate of 40%

iii
. What is the net cash outflow at the beginning of the first year that Moore Corporation should use in a capital
budgeting analysis?
a. $(85,000) c. $(96,000)
b. $(90,000) e. $(105,000)

iv
. What is the net cash flow for the third year that Moore Corporation should use in a capital budgeting analysis?
a. $68,400 c. $64,200
b. $68,000 d. $79,000

v
. What is the net cash flow for the tenth year of the project that Moore Corporation should use in a capital
budgeting analysis?
a. $100,000 c. $68,400
b. $81,000 d. $63,000

Questions 10 through 13 are based on the following information. Gleim

The Dickins Corporation is considering the acquisition of a new machine at a cost of $180,000. Transporting the
machine to Dickins’ plant will cost an additional $18,000. It has a 10-year life and is expected to have a salvage
value of $10,000. Furthermore, the machine is expected to produce 4,000 units per year with a selling price of $500
and combined direct materials and direct labor costs of $450 per unit. Federal tax regulations permit machines of
this type to be depreciated using the straight-line method over 5 years with no estimated salvage value. Dickins has
a marginal tax rate of 40%.

vi
. What is the net cash outflow at the beginning of the first year that Dickens should use in a capital budgeting
analysis?
a. $(170,000) c. $(192,000)
b. $(180,000) d. $(210,000)

vii
. What is the net cash flow for the third year that Dickins Corporation should use in a capital budgeting analysis?
a. $136,800 c. $128,400
b. $136,000 d. $107,400

viii
. What is the net cash flow for the tenth year of the project that Dickins should use in a capital budgeting analysis?
 a. $200,000 c. $136,800
b. $158,000 d. $126,000

ix
. What is the approximate payback period on the new machine?
a. 1.05 years. c. 1.33 years
b. 1.54 years d. 2.22 years

ACCOUNTING RATE OF RETURN

Numerator
x
. Lin Co. is buying machinery it expects will increase average annual operating income by $40,000. The initial
increase in the required investment is $60,000, and the average increase in required investment is $30,000. To
compute the accrual accounting rate of return, what amount should be used as the numerator in the ratio? (E)
a. $20,000 c. $40,000
b. $30,000 d. $60,000

ARR on Net Initial Investment

Cash Flows Given, Ignore Income Tax
46. An investment opportunity costing $150,000 is expected to yield net cash flows of $45,000 annually for five
years. The cost of capital is 10%. The book rate of return would be (M)
a. 10%. c. 30%.
b. 20%. d. 33.3%. L & H 10e

50. An investment opportunity costing $80,000 is expected to yield net cash flows of $25,000 annually for four years.
The cost of capital is 10%. The book rate of return would be (M)
a. 10.0%. c. 21.3%.
b. 12.5%. d. 32.0%. L & H 10e

*. The Habagat Inc. is planning to spend P600,000 for a machine that it will depreciate on a straight-line basis over
a ten-year period with no terminal disposal price. The machine will generate cash flow from operations of
P120,000 a year. Ignoring income taxes, what is the accounting rate of return on the net initial investment? (M)
a. 5% c. 10%
b. 12% d. 15% RPCPA 0595

xi
. A project requires an investment of $80,000 in equipment. Annual cash inflows of $16,000 are expected to occur
for the next 8 years. No salvage value is expected. The company uses the straight-line method of depreciation
with no mid-year convention. Ignore income taxes.
 The accounting rate of return on original investment for the project is (M)
a. 6.25% c. 16.00%
b. 7.50% d. 20.00% H&M

*. Doro Co. is considering the purchase of a $100,000 machine that is expected to result in a decrease of $25,000
per year in cash expenses after taxes. This machine, which has no residual value, has an estimated useful life
of 10 years and will be depreciated on a straight-line basis. For this machine, the accounting rate of return
based on the initial investment will be (M)
a. 10% c. 25%
b. 15% d. 35% AICPA 1189 II-40

68. (Ignore income taxes in this problem.) The Jason Company is considering the purchase of a machine that will
increase revenues by $32,000 each year. Cash outflows for operating this machine will be $6,000 each year.
The cost of the machine is $65,000. It is expected to have a useful life of five years with no salvage value. For
this machine, the simple rate of return is: (E)
a. 20%. c. 49.2%.
b. 40%. d. 9.2%. G & N 9e

Old Machine has Scrap Value, Net Cost Savings, Ignore Income Tax
67. (Ignore income taxes in this problem.) Denny Corporation is considering replacing a technologically obsolete
machine with a new state-of-the-art numerically controlled machine. The new machine would cost $450,000 and
would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new
machine would cost $20,000 per year to operate and maintain, but would save $100,000 per year in labor and
other costs. The old machine can be sold now for scrap for $50,000. The simple rate of return on the new
machine is closest to: (M)
a. 8.75%. c. 7.78%.
b. 20.00%. d. 22.22%. G & N 9e

After-tax Cash Flow Given

*. Benny Company is planning to purchase a new machine for P600,000. The new machine will be depreciated on
the straight-line basis over six-year period with no salvage, and a full year’s depreciation will be taken in the year
of acquisition. The new machine is expected to produce cash flow from operations, net of income taxes, of
P150,000 a year in each of the next six years. The accounting (book value) rate of return on the initial
investment is expected to be (D)
a. 16.7% c. 8.3%
b. 12.0% d. 25.0% RPCPA 0598

xii
. Hooker Oak Furniture Company is considering the purchase of wood cutting equipment. Data on the equipment
are as follows:

Original investment $30,000

 Net annual cash inflow $12,000
Expected economic life in years 5
Salvage value at the end of five years $3,000

The company uses the straight-line method of depreciation with no mid-year convention.
What is the accounting rate of return on original investment rounded off to the nearest percent, assuming no
taxes are paid? (D)
a. 40.0% d. 24.0%
b. 72.7% e. 22.0%
c. 20.0% H&M

ARR on Average Investment

Cash Flows Given, Ignore Income Tax
66. Microsoft Co. is considering the purchase of a $100,000 machine that is expected to result in a decrease of
$15,000 per year in cash expenses. This machine, which has no residual value, has an estimated useful life of
10 years and will be depreciated on a straight-line basis. For this machine, the accounting rate of return would
be (M)
a. 10 percent. c. 30 percent.
b. 15 percent. d. 35 percent. Barfield

72. Mat Company is negotiating to purchase equipment that would cost P200,000 with the expectation that P40,000
per year could be saved in after-tax cash costs if the equipment were acquired. The equipment’s estimated
useful life is 10 years, with no salvage value, and would be depreciated by the straight-line method. Mat’s
minimum desired rate of return is 12%. Present value of an annuity of 1 at 12% for 10 periods is 5.65. Present
value of 1 due in 10 periods at 12% is 0.322.
The average accrual accounting rate of return during the first year of asset’s use is
A. 20.0% C. 10.0%
B. 10.5% D. 40.0% Pol Bobadilla

Required Investment
ARR based on Initial Investment Given
xiii
. The Mutya ng Pasig Company, a calendar company, purchased a new machine for P280,000 on January 1.
Depreciation for tax purposes will be P35,000 annually for eight years. The accounting (book value) rate of
return (ARR) is expected to be 20% on the initial increase in required investment. On the assumption of a
uniform cash inflow, this investment is expected to provide annual cash flow from operations, before 30 percent
income taxes, of (M)
A. P80,000 C. P115,000
B. P91,000 D. P175,000 Pol Bobadilla
ARR based on Average Investment Given
xiv
. The Zambales Co. is planning to purchase a new machine which it will depreciate for book purposes, on a
straight-line basis over a ten-year period with no salvage value and a full year-‘s depreciation taken in the year of
acquisition. The new machine is expected to product cash flow from operations, net of income taxes, of
P175,000 a year in each of the next ten years. The accounting (book value) rate of return on the average
investment is expected to be 15%. How much will the new machine cost? (M)
A. P1,000,000 C. P1,666,667
B. P700,000 D. P1,800,000 Pol Bobadilla

Required Life
83. The IRV Company has made an investment in video and recording equipment that costs P106,700. The
equipment is expected to generate cash inflows of P20,000 per year. How many years will the equipment have
to be used to provide the company with a 10% average accounting rate of return on its investment?
A. 7.28 years C. 5.55 years
B. 9.05 years D. 4.75 years. Pol Bobadilla

Sensitivity Analysis
*. Lyben Inc. is planning to produce a new product. To do this, it is necessary to acquire a new equipment that will
cost the company P100,000. The estimated life of the new equipment is five years with no salvage value. The
estimated income and costs based on expected sales of P10,000 units per year are:

Sales @ P10.00 per unit P100,000

Costs @ P8.00 per unit 80,000

Net income P 20,000

The accounting rate of return based on initial investment is 20%

What will be the accounting rate of return based on initial investment of P100,000 if management decrease its
selling price of the new product by 10%? (M)
a. 5% c. 15%
b. 10% d. 20% RPCPA 1077

PAYBACK PERIOD
Initial Investment
*. APJ, Inc. is planning to purchase a new machine that will take six years to recover the cost. The new machine is
expected to produce cash flow from operations, net of income taxes, of P4,500 a year for the first three years of
the payback period and P3,500 a year of the last three years of the payback period. Depreciation of P3,000 a
year shall be charged to income of the six years of the payback period. How much shall the machine cost? (M)
a. P12,000 c. P24,000
b. P18,000 d. none of these RPCPA 1087
92. Louis recently invested in a project that has an expected annual cash inflow of $7,000 for 10 years, and an
expected payback period of 3.6 years. How much did Louis invest in the project?
a. $19,444 c. $25,200
b. $36,000 d. $40,000 Barfield

Minimum Annual Before-tax Operating Cash Savings

xv
. Whatney Company is considering the acquisition of a new, more efficient press. The cost of the press is
$360,000, and the press has an estimated 6-year life with zero salvage value. Whatney uses straight-line
depreciation for both financial reporting and income tax reporting purposes and has a 40% corporate income tax
rate. In evaluating equipment acquisition of this type, Whatney uses a goal of a 4-year payback period. To meet
Whatney’s desired payback period, the press must produce a minimum annual before-tax operating cash
savings of (M)
i
.$6,000 x 0.404 (PVIF, n = 8, 12%) = $2,424

ii
.

Revenues $48,100
Less: Variable costs (16,000)
Fixed out-of-pocket costs (10,000)
Annual cash inflows $22,000
PVAF, n = 8, 12% x 4.968

Present value $109,296

iii
.Answer (D) is correct. Initially, the company must invest $105,000 in the machine, consisting of the invoice price of
$90,000, the delivery costs of $6,000, and the installation costs of $9,000.
Answer (A) is incorrect because $(85,000) erroneously includes salvage value but ignores delivery and installation
costs. Answer (B) is incorrect because $(90,000) ignores the outlays needed for delivery and installation costs, both of
which are an integral part of preparing the new asset for use. Answer (C) is incorrect because $(96,000) fails to include
installation costs in the total.

iv
.Answer (A) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price - $450 of variable
costs), or a total of $100,000 per year. This amount will be subject to taxation, but, for the first 5 years, there will be a
depreciation deduction of $21,000 per year ($105,000 cost divided by 5 years). Therefore, deducting the $21,000 of
depreciation expense from the $100,000 of contribution margin will result in taxable income of $79,000. After income
taxes of $31,600 ($79,000 x 40%), the net cash flow in the third year is $68,400 ($100,000 - $31,600).
Answer (B) is incorrect because $68,000 deducts salvage value when calculating depreciation expense, which is not
required by the tax law. Answer (C) is incorrect because $64,200 assumes depreciation is deducted for tax purposes
over 10 years rather than 5 years. Answer (D) is incorrect because $79,000 is taxable income.

v
.Answer (D) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price - $450 of variable
costs), or a total of $100,000 per year. This amount will be subject to taxation, as will the $5,000 gain on sale of the
investment, bringing taxable income to $105,000. No depreciation will be deducted in the tenth year because the asset
was fully depreciated after 5 years. Because the asset was fully depreciated (book value was zero), the $5,000 salvage
value received would be fully taxable. After income taxes of $42,000 ($105,000 x 40%), the net cash flow in the tenth
year is $63,000 ($105,000 - $42,000).
Answer (A) is incorrect because $100,000 overlooks the salvage proceeds and the taxes to be paid. Answer (B) is
incorrect because $81,000 miscalculates income taxes. Answer (C) is incorrect because $68,400 assumes that
depreciation is deducted; it also overlooks the receipt of the salvage proceeds.

vi
.Answer (D) is correct. Delivery and installation costs are essential to preparing the machine for its intended use. Thus,
the company must initially pay $210,000 for the machine, consisting of the invoice price of $180,000, the delivery costs
of $12,000, and the $18,000 of installation costs.
 Answer (A) is incorrect because $(170,000) includes salvage value and ignores delivery and installation costs. Answer
(B) is incorrect because $(180,000) ignores the outlays needed for delivery and installation. Answer (C) is incorrect
because $(192,000) excludes installation costs.

vii
.Answer (A) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price - $450 variable
costs), a total of $200,000 per year for 4,000 units. This amount will be subject to taxation. However, for the first 5 years,
a depreciation deduction of $42,000 per year ($210,000 cost ÷ 5 years) will be available. Thus, annual taxable income
will be $158,000 ($200,000 - $42,000). At a 40% tax rate, income tax expense will be $63,200, and the net cash inflow
will be $136,800 ($200,000 - $63,200).
Answer (B) is incorrect because $136,000 results from subtracting salvage value when calculating depreciation
expense. Answer (C) is incorrect because $128,400 assumes depreciation is recognized over 10 years. Answer (D) is
incorrect because $107,400 assumes that depreciation is recognized over 10 years and that it requires a cash outlay.

viii
.Answer (D) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price - $450 of variable
costs), a total of $200,000 per year for 4,000 units. This amount will be subject to taxation, as will the $10,000 gain on
sale of the investment, resulting in taxable income of $210,000. No depreciation will be deducted in the tenth year
because the asset was fully depreciated after 5 years. Because the asset was fully depreciated (book value was $0), the
$10,000 received as salvage value is fully taxable. At 40%, the tax on $210,000 is $84,000. After subtracting $84,000 of
tax expense from the $210,000 of inflows, the net inflows amount to $126,000.
Answer (A) is incorrect because $200,000 overlooks the salvage proceeds and the taxes to be paid. Answer (B) is
incorrect because $158,000 equals annual taxable income for each of the first 5 years. Answer (C) is incorrect because
$136,800 is the annual net cash inflow in the second through the fifth years.

ix
.Answer (B) is correct. When annual cash inflows are uniform, the payback period is calculated by dividing the initial
investment ($210,000) by the annual net cash inflows ($136,800). Dividing $210,000 by $136,800 produces a payback
period of 1.54 years.
Answer (A) is incorrect because 1.05 years fails to subtract income taxes. Answer (C) is incorrect because 1.33 years
includes taxable income in the denominator instead of cash flows. Answer (D) is incorrect because 2.22 years subtracts
depreciation from cash flows.

x
.Answer (C) is correct. The accounting rate of return method (ARR) computes an approximate rate of return which
ignores the time value of money. It is computed as follows:
ARR = expected increase in net income Average investment.
Therefore, $40,000 (as stated in problem) is the expected increase in annual income.
xi
.[$16,000 – ($80,000/8)]/$80,000 = 7.5%

xii
.{$12,000 – [($30,000 - $3,000)/5)]}/$30,000 = 22%

xiii
.Net Income After Tax (P280,000 x 20%) P 56,000

Divide by (1 – 0.30) 0.70

Net Income before Tax P 80,000
Add Depreciation 35,000
 Cash Flow before Tax P115,000

xiv
.Net Income after Tax 7.5% of Investment

Depreciation 10.0% of Investment

After-tax Cash Flow 17.5% of Investment = P175,000
Investment (P175,000 17.5%) = P1,000,000

xv
.Answer (B) is correct. Payback is the number of years required to complete the return of the original investment. Given
a periodic constant cash flow, the payback period equals net investment divided by the constant expected periodic after-
tax cash flow. The desired payback period is 4 years, so the constant after-tax annual cash flow must be $90,000
($360,000 ÷ 4). Assuming that the company has sufficient other income to permit realization of the full tax savings,
depreciation of the machine will shield $60,000 ($360,000 ÷ 6) of income from taxation each year, an after-tax cash
savings of $24,000 (40% x $60,000). Thus, the machine must generate an additional $66,000 ($90,000 - $24,000) of
after-tax cash savings from operations. This amount is equivalent to $110,000 [$66,000 ÷ (1.0 - .4)] of before-tax
operating cash savings.
Answer (A) is incorrect because $90,000 is the total desired annual after-tax cash savings. Answer (C) is incorrect
because $114,000 results from adding, not subtracting, the $24,000 of tax depreciation savings to determine the
minimum annual after-tax operating savings. Answer (D) is incorrect because $150,000 assumes that depreciation is not
tax deductible.