The Morgan Company has been awarded a six-year contract to provide repair service to a commercial bus line. Morgan Company has gathered the following data associated with the items needed for this contract:

The special equipment is in Class 7 with a maximum 15% CCA rate. The income tax rate is 40%, and Morgan's after-tax cost of capital is 14%. At the end of six years, the working capital will be released for use elsewhere.

-The present value of the total after-tax net cash inflows (outflows),excluding any CCA tax shield,in Year 4 is closest to which of the following?

Question

The Morgan Company has been awarded a six-year contract to provide repair service to a commercial bus line. Morgan Company has gathered the following data associated with the items needed for this contract:

The special equipment is in Class 7 with a maximum 15% CCA rate. The income tax rate is 40%, and Morgan's after-tax cost of capital is 14%. At the end of six years, the working capital will be released for use elsewhere.

-The present value of the total after-tax net cash inflows (outflows),excluding any CCA tax shield,in Year 4 is closest to which of the following?

Quizplus · Accepted Answer

1. Calculate the cost of each item: 
- Annual cost = Purchase price / Expected life 
- Item A: $10,240 / 4 = $2,560 
- Item B: $20,000 / 10 = $2,000 
- Item C: $1,600 / 4 = $400

2. Calculate the present value of the net cash inflows (outflows) for each year: 
- Year 0 (Initial Outlay): 
   - ($10,240 + $20,000 + $1,600) = - $31,840 
- Year 1: 
   - Net cash inflow: $40,000 
   - CCA tax shield: ($10,240 x 15%) x 40% = $614.40 
   - Total after-tax net cash inflow: $40,000 + $614.40 = $40,614.40 
   - Present value: $40,614.40 / (1 + 14%) = $35,520 
- Year 2: 
   - Net cash inflow: $60,000 
   - CCA tax shield: ($20,000 x 15%) x 40% = $1,200 
   - Total after-tax net cash inflow: $60,000 + $1,200 = $61,200 
   - Present value: $61,200 / (1 + 14%)^2 = $47,689.82 
- Year 3: 
   - Net cash inflow: $80,000 
   - CCA tax shield: ($10,240 x 15%) x 40% = $614.40 
   - Total after-tax net cash inflow: $80,000 + $614.40 = $80,614.40 
   - Present value: $80,614.40 / (1 + 14%)^3 = $56,350.49 
- Year 4: 
   - Net cash inflow: $100,000 
   - CCA tax shield: ($2,560 x 15%) x 40% = $153.60 (Item A)
   - ($2,000 x 15%) x 40% = $120 (Item B)
   - ($400 x 15%) x 40% = $24 (Item C)
   - Total CCA tax shield: $297.60 
   - Total after-tax net cash inflow: $100,000 + $297.60 = $100,297.60 
   - Present value: $100,297.60 / (1 + 14%)^4 = $64,918.22

3. Sum up the present value of the net cash inflows (outflows) for all years: 
- Present value of total after-tax net cash inflows (outflows), excluding any CCA tax shield, in Year 4 is: 
   - ($31,840) + $35,520 + $47,689.82 + $56,350.49 + $64,918.22 = $173,638.53 
   - Excluding any CCA tax shield in Year 4: $173,638.53 - $297.60 = $173,340.93 
   
Thus, the closest answer is C) $35,520.

The Morgan Company Has Been Awarded a Six-Year Contract to Provide