A company wants to expand its operations. One capital investment proposal under consideration is the acquisition of additional equipment. The cost of initial investment is estimated to be $75,000 with useful life of 6 years and the disposal value of $15,000. Straight-line depreciation method will be used for both financial and tax purposes.
The expansion will bring in an estimated $38,000 cash every year; the annual operating expenses are around $17,000. At the end of the third year, a one-time tune-up is required for a cost of $8,000. Because of the expansion, working capital in the amount of $14,000 must be committed.
The tax rate and the discount rate are 40 percent and 12 percent, respectively.
Required:
1. Evaluate the expansion proposal using the net present value analysis.
2. Assume that at the end of the fourth year, because of unforeseen reasons, the equipment is salvaged for $50,000. What are the tax consequences of the disposal?