LeBron Corporation is considering the purchase of an asset for $400,000.It is expected that the product manufactured by the equipment can be sold for $150,000 and that there will be annual production costs, exclusive of depreciation, equal to $80,000.The asset will have a 10-year life, no terminal salvage value, and straight-line depreciation will be used for tax purposes.The tax rate applicable to LeBron Corporation is 30%.If the equipment is purchased, the total net after-tax effect on cash flows over the entire life of the investment is _____.

Question

Quizplus · Accepted Answer

The total net after-tax effect on cash flows over the entire life of the investment can be calculated as follows:

Net cash inflow from sales = $150,000
Annual production costs = $80,000
Depreciation expense = $400,000 / 10 = $40,000 per year
Tax rate = 30%

Year 1:
Cash inflow: $150,000
Cash outflow: $80,000 + $40,000 = $120,000
Taxable income: $150,000 - $80,000 - $40,000 = $30,000
Tax expense: $30,000 x 30% = $9,000
Net cash flow: $150,000 - $80,000 - $40,000 - $9,000 = $21,000

Years 2-9:
Cash inflow: $150,000
Cash outflow: $80,000 + $40,000 = $120,000
Taxable income: $150,000 - $80,000 - $40,000 = $30,000
Tax expense: $30,000 x 30% = $9,000
Net cash flow: $150,000 - $80,000 - $40,000 - $9,000 = $21,000

Year 10:
Cash inflow: $150,000
Cash outflow: $80,000 + $40,000 = $120,000
Taxable income: $150,000 - $80,000 - $40,000 = $30,000
Tax expense: $30,000 x 30% = $9,000
Recaptured depreciation: $40,000
Net cash flow: $150,000 - $80,000 - $40,000 - $9,000 + $40,000 = $61,000

Total net after-tax effect on cash flows over the entire life of the investment:
Years 1-9: $21,000 x 9 = $189,000
Year 10: $61,000
Total: $189,000 + $61,000 = $250,000
Since the initial investment in the equipment is $400,000, the total net after-tax effect on cash flows over the entire life of the investment is $400,000 - $250,000 = $150,000 inflow.

Therefore, the best choice is C.

LeBron Corporation Is Considering the Purchase of an Asset for $400,000.It