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Not sure how to answer this question – John, please help. Thanks
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Juicy and 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 and Co pays corporation tax at 30% (as the cash flow occurs) and due to the health benefits of juicing, the machine attracts 100% tax allowable depreciation immediately.
Given the cost of capital is 10%, what is the minimum value of the pre-tax contract revenue receivable in 2 years which would be required to recover the net cost of the juicer?
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I am puzzled that you have not understood from the answer in the BPP book 🙂
You need to use a little bit of algebra.
Suppose the revenue is X
Then the cash flows are:
0 initial cost (150,000)
0 tax saving on cost (30% x 150,000) 45,000
2 revenue X
2 tax on revenue (0.3X)
which simplifies to
0 (105,000)
2 0.7X
For the NPV to be zero, the PV of 0.7X must be equal to 105,000
The PV of 0.7X is 0.7X multiplied by the 2 year discount factor at 10%.
So X = (105,000 / 2 year discount fact at 10%) / 0.7
(Check that the question is exactly as you have copied it. If the revenue is each year for 2 years, then you need to do as above but divide by the 2 year annuity factor at 10%).