Tutor profile: Satya Narayan M.
Subject: Corporate Finance
Suppose that the initial cost of an investment is $75,000, the present value of tax saving from depreciation is $2,000, and the present value after tax terminal value is $30,000. It is expected that the investment will increase yield and this operating receipts by $15,000 per year but it will cost $5,000 a year to pay for electricity, maintenance, and additional labor. There is a pretax discount rate of 12% while the marginal tax rate over the next 5 years is 20%. What is the break-even price of operating receipt?
Answer: Given: Pretax discount rate = 12% and tax rate = 20% Hence: Post tax discount rate = 12% * (1 - 20%) = 9.60% Given: Initial investment = $75,000 Present value of tax saving from depreciation is = $2,000 Present value after tax terminal value is = $30,000 We know that at break-even price of operating receipt NPV will be equal to zero. Hence: 0 = PV of cash flow from after tax operating receipt + Present value of tax saving from depreciation + Present value after tax terminal value – Initial Investment =>PV of cash flow from after tax operating receipt = Initial Investment - Present value of tax saving from depreciation + Present value after tax terminal value => PV of cash flow from after tax operating receipt = 75000 - 2000 - 30000 = $43,000 Annual after tax operating receipt net of cost = PV of cash flow from after tax operating receipt / PV of $1 annuity for 5 years at discount rate of 9.60% PV of $1 annuity for 5 years at 9.60% = (1 - 1 / (1 + 9.60%) 5) / 9.60% = 3.8298436 Annual after tax operating receipt net of cost = 43,000 / 3.8298436 = 11227.61 Before tax operating receipt net of cost = Annual after tax operating receipt net of cost / (1 – Tax rate) =11227.61 / (1 - 20%) =14034.51 Hence break-even operating receipt = before tax operating receipt net of cost + Annual operating cost = 14034.51 + 5000 = $19,034.51 Hence break-even operating receipt = $19,034.51
Robert wants a fixed -rate mortgage to buy a new home for $180,000. The mortgage bank will charge 7.10% APR for this 300 month loan. Robert could afford monthly payment of $950 only and hence offered to pay off any remaining balance at the end of loan period in form a Single balloon payment. If the bank agreed, what will be the amount of the single balloon payment Robert has to make his monthly payment is $950?
Answer: Loan amount = $180,000 Monthly interest rate = APR/ 12 = 7.1%/12 Monthly payment = $950 Calculation of single balloon payment: Method 1 using excel function FV Single balloon payment = FV (rate, nper, pmt, pv, fv, type) = FV (7.1%/12, 300, 950, -180000, 0,0) = $274,646.63 Single balloon payment = $274,646.63 Method 2 using formula First we need to calculate present value of month payments: Present value of monthly payments = Periodic payment * (1 – 1 / (1 + Periodic interest) ^ Number of periods) / Periodic Interest = 950 * (1 - 1/ (1 + 7.1%/12) 300) / (7.1%/12) = $133,207.8373 Present value of single balloon payment = Loan amount - Present value of monthly payments = 180000 - 133,207.8373 = 46792.1627 Single balloon payment = Future value of 46792.1627 = 46792.1627 * (1 + 7.1%/12) 300 = $274646.63 Hence: Single balloon payment Robert has to make at the end of loan period = $274,646.63
In 2017, ABC Construction Corporation got a 2 year contract for price $2,100,000. ABC Recognizes revenue over time based on percentage of completion method. The following are extracts from its financial statement: Balance sheet: Accounts receivable (from construction billing) $35,000 Construction in progress $150,000 Less: Billing on construction contract ($143,000) Cost and Profit of uncompleted contracts in excess of billing $7,000 Income Statement: Income before tax from contract recognized in 2017 $25,000 Question: 1. What is actual cost incurred in 2017? 2.What is amount of cash collected in 2017? 3.What is the estimated cost to complete as of end of 2017?
Answer 1: Actual costs incurred in 2017 = Construction in progress - Income recognized =150000 - 25000 = $125,000 Answer 2: Cash collected in 2017 = Billings in 2017 - Ending balance of account receivable = 143000 - 35000 = $108,000 Answer 3: Revenue recognized = Percentage completion * Total Contract price Percentage completed = Revenue recognized / Total Contract price Revenue Recognized = Actual cost incurred this year + Income recognized = 125000 + 25000 =$125,000 Hence: Percentage completed = 150000 / 2100000 (i) Let us assume estimated cost to complete as of end of 2017 = X Percentage completion = Actual cost incurred till date / Estimated total cost (ii) Estimated total cost = Actual cost incurred till date + Estimated cost to complete Hence: From (i) and (ii): Actual cost incurred till date / Estimated total cost = 150000 / 2100000 Estimated total cost = 2100000 * 125000 / 150000 = $1,750,000 Estimated cost to complete = 1750000 - 125000 = $1,625,000 Estimated cost to complete = $1,625,000 Answers: 1 Actual costs incurred in 2017 $125,000 2 Cash collected in 2017 $108,000 3 Estimated cost to complete as of end of 2017 $1,625,000
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