Nakama Corporation is considering investing in a project that would have a 4 year expected useful life. The company would need to invest $124,000 in equipment that will have zero salvage value at the end of the project. Annual incremental sales would be $410,000 and annual cash operating expenses would be $260,000. In year 3 the company would have to incur one-time renovation expenses of $74,000. Working capital in the amount of $10,000 would be required. The working capital would be released for use elsewhere at the end of the project. The company's tax rate is 30%. The company uses straight-line depreciation on all equipment.The income tax expense in year 2:
A) $35,700
B) $32,700
C) $28,300
D) $13,500

Question

Quizplus · Accepted Answer

First, we need to calculate the annual depreciation expense:
Depreciation expense = Equipment cost / useful life
Depreciation expense = $124,000 / 4 years
Depreciation expense = $31,000 per year

Now we can calculate the annual cash flows:
Year 1: $410,000 - $260,000 - $31,000 - $10,000 = $109,000
Year 2: $410,000 - $260,000 - $31,000 - $10,000 = $109,000
Year 3: $410,000 - $260,000 - $31,000 - $74,000 - $10,000 = $35,000
Year 4: $410,000 - $260,000 - $31,000 - $10,000 = $109,000

To calculate income before taxes (EBT), we deduct depreciation expense from the annual cash flows:
Year 1: $109,000 - $31,000 = $78,000
Year 2: $109,000 - $31,000 = $78,000
Year 3: $35,000 - $31,000 = $4,000
Year 4: $109,000 - $31,000 = $78,000

Now we can calculate income taxes:
Year 1: $78,000 x 30% = $23,400
Year 2: $78,000 x 30% = $23,400
Year 3: $4,000 x 30% = $1,200
Year 4: $78,000 x 30% = $23,400

Therefore, the income tax expense in year 2 is $23,400. None of the answer choices are correct.

Nakama Corporation Is Considering Investing in a Project That Would