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Tax Benefit for Proposal

Some notes/clarifications to assist in doing the evaluation/analysis portion of the assignment:

You may do the analysis using paper and pencil, but use of Excel would prove beneficial.
You may want to set up a schedule in which column A is the Description of the specific cash flow being considered, column B is year 0 (proposal introduction, i.e. "start-up"), columns C through G are the analysis years 1 through 5, and column H is year 6 (proposal completion, i.e. "shut-down").
Column A should identify each of the elements that must be analyzed when considering the proposal's cash flows. Be sure to list each inflow and outflow.
Sales Revenue: Estimated annual revenue is given for year one, and is affected by an annual rate of revenue growth.
Variable Expenses: The amount of variable expenses in implied by the contribution margin % that is given.
Fixed Costs: By definition, fixed costs remain fixed in each of the analysis years.
Tax Benefits: annual tax benefits are tied to an estimated 40% tax rate. Therefore, proposal 1 depreciation expense of $220,000/year means a tax savings impact on the analysis of $88,000/year. Likewise, proposal 2 depreciation expense of $175,000/year means a tax savings impact on the analysis of $70,000/year.
Present Value: The annual cash inflows and outflows must be totaled for each year (0-6); the present value of that year's annual cash flow must be calculated for each of the years.
Project NPV: The sum of each of these present value calculations is the project Net Present Value.
Sensitivity Analysis: Bracketing the 12% cost of capital plus or minus a few per cent will create a range, identifying the affect that 10% and 15% (for example) would have on the NPV. Likewise, bracketing the year one revenue number plus or minus $100,000 will create a range, identifying the sensitivity that more or less contribution margin has on the NPV.

Here's how to prepare an analysis and calculate NPV (example = Proposal One):

Step 1 of 3: Create analysis schedule (organize schedule to include eight columns):

Place column headings as follows:

Description Yr0(start-up) Yr1 Yr2 Yr3 Yr4 Yr5 Yr6(shut-down)

Revenue 0 600 636 tbd tbd tbd 0

(note: we are told that there will be 6% annual growth).

Variable Exp 0 -360 -381 tbd tbd tbd 0

(note: we are told that contribution margin is 40% of sales, therefore variable exp equals 60% of sales)

_____________________________________________________________________

Cont Margin 0 240 254 tbd tbd tbd 0

Tax Benefits 0 88 88 88 88 88 0

Fixed Costs 0 -120 -120 -120 -120 -120 0

Investment -1,500 0 0 0 0 0 0

Advertising -140 0 0 0 0 0 0

Inventory -150 0 0 0 0 0 0

Salvage 0 0 0 0 0 0 400

Invent Recov 0 0 0 0 0 0 150

______________________________________________________________________

Sum -1,790 208 222 tbd tbd tbd 550,000

Step 2 of 3: Calculate PV for each annual sum (using factor table on p. 484):

PV Yr0 = $-1,790,000

PV Yr1 = $185,723 (i.e. $208,000 x .8929 = $185,723) (see p.484 for reqd factors)

PV Yr2 = $177,297 (i.e. $222,400 x .7972 = $177,297)

PV Yr3 = must be calculated

PV Yr4 = must be calculated

PV Yr5 = must be calculated

PV Yr6 = $278,630 (i.e. $550,000 x .5066 = $278,630)

Step 3 of 3: Sum of all (7) PV's noting positive and negative values = NPV

Here's how to do the tax benefit calculation (example = Proposal One):

1. Calculate the Net Investment = $1,500,000 less $400,000 salvage = $1,100,000

2. Then, calculate Annual Depreciation = $1,100,000 Net Investment above divided by 5 years = $220,000

3. Finally, calculate Annual Tax Benefit = $220,000 Annual Depr times 40% tax rate = $88,000

Of course, you will need to calculate the Tax Benefit for Proposal Two using the same steps, different numbers

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Some notes/clarifications to assist in doing the evaluation/analysis portion of the assignment:

You may do the analysis using paper and pencil, but use of Excel would prove beneficial.
You may want to set up a schedule in which column A is the Description of the specific cash flow being considered, column B is year 0 (proposal introduction, i.e. "start-up"), columns C through G are the analysis years 1 through 5, and column H is year 6 (proposal completion, i.e. "shut-down").
Column A should identify each of the elements that must be analyzed when considering the proposal's cash flows. Be sure to list each inflow and outflow.
Sales Revenue: Estimated annual revenue is given for year one, and is affected by an annual rate of revenue growth.
Variable Expenses: The amount of variable expenses in implied by the contribution margin % that is given.
Fixed Costs: By definition, fixed costs remain fixed in each of the analysis years.
Tax Benefits: annual tax benefits are tied to an estimated 40% tax rate. Therefore, proposal 1 depreciation expense of $220,000/year means a tax savings impact on the analysis of $88,000/year. Likewise, proposal 2 depreciation expense of $175,000/year means a tax ...

Solution Summary

This provides the steps to calculate the Tax Benefit for Proposal

$2.19