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Hi Dear Tutor, I have a question and need explanation please.
Juicy Co is considering investing in a new industrial juicer for use on a new contract. It will cost $150 000 and will last 2 years. Juicy Co pays corporation tax at 30% ( as the cash flows occur) and, due to health benefits of juicing, the machine attracts 100% tax allowable depreciation immediately.
Given a cost of capital of 10%, what is the minimum value of the pre tax contract revenue receivable in 2 years which would be required to cover the net cost of the juicer?
Cost—————–(150000)
Tax benefits——45000
cost==========(105000)105000/(0.7*0.826)=181598-I did not get this part how I can get revenue by multiplying the cost to adjusted cost of capital rate of 10% in 2 years?
Suppose that the revenue in 2 years time is X.
There will be tax payable of 30%, and therefore the net cash receipt in 2 years time will be 0.7X (70% of X).The present value of this will be 0.7X x 0.826 (the 2 year discount factor at 10%) and the minimum PV must be equal to 105,000.
Therefore 0.7X x 0.826 = 105,000
Therefore X = 105,000 / (0.7 x 0.826)
Years—————–0———–1———–2
Revenue————————————–x
Machine cost—–(150000)
Tax benefits———45000
tax on revenue—————————–0.7Net cash flows=(105000)————–0.7x=Npv
D.F10%————1————————–0.826
PV————–(105000)+0.7x*1/1.1^2=0
(105000)=0.7x/1.21
0.7x=(105000)*1.21
x=127050/0.7=181500does we consider here 181500 as NPV?Do you think my method is ok?
My question here is that when we solve working capital related question we only consider tax benefits on depreciation and do not consider tax on revenue?why?
Yea now understood of course we consider it on operating cash flow before tax so it is simple
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