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Tax Benefit for Proposal

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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 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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https://brainmass.com/economics/cost-benefit-analysis/tax-benefit-for-proposal-71958

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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
See Also This Related BrainMass Solution

Clark Paints Proposal

Clark Paints: The production department has been investigating possible ways to trim total production costs. One possibility currently being examined is to make the paint cans instead of purchasing them. The equipment needed would cost $200,000, with a disposal value of $40,000, and it would be able to produce 5,500,000 cans over the life of the machinery. The production department estimates that approximately 1,100,000 cans would be needed for each of the next five years.

The company would hire three new employees. These three individuals would be full-time employees working 2,000 hours per year and earning $12.00 per hour. They would also receive the same benefits as other production employees, 18% of wages, in addition to $2,500 of health benefits.

It is estimated that the raw materials will cost 25 cents per can and that other variable costs would be 5 cents per can. Since there is currently unused space in the factory, no additional fixed costs would be incurred if this proposal is accepted.

It is expected that cans would cost 45 cents each if purchased from the current supplier. The company's minimum rate of return (hurdle rate) has been determined to be 12% for all new projects, and the current tax rate of 35% is anticipated to remain unchanged. The pricing for a gallon of paint, as well as the number of units sold, will not be affected by this decision. The unit-of-production depreciation method would be used if the new equipment is purchased.

1. Based on the above information and using Excel and the provided template, calculate the following items for this proposed equipment purchase:
o Annual cash flows over the expected life of the equipment
o Payback period
o Annual rate of return
o Net present value
o Internal rate of return

2. Would you recommend the acceptance of this proposal? Why or why not? Prepare a short double-spaced Word paper elaborating on and supporting your answer.

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