Lowell D. Outland
IET310-301
Engineering Economics Analysis
IET 310: 301 Engineering Economic Analysis: Fall 2011
Homework # 9 (Based on Chapter 12) (50 points)
Due date - November 28’Th (Monday), 2011, before 11.55 PM EST
Prof. Rajeev Nair
1. The KJL Corporation received $10,000,000 from the sales of their products during the
current year. A total of $1,000 of these sales was never actually collected and was accounted
for as bad debts. The company spent $3,000,000 in the production and warehousing of their
products during the current year. A total of $1,000,000 was spent for wages and salaries,
$500,000 was paid out in interest on long-term loans, $700,000 was spent for rental of space
and equipment, and $600,000 depreciation was charged off. Compute the KJL Corporation’s
income tax bill for the current year, if the base tax rate is 22% and the surtax rate is 26% (10
points).
Income
10,000,000
Expensed
$1,000
$3,000,000
$1,000,000
500,000
700,000
600,000
Reason
Bad Debt
Production
and
warehousing
wages and
salaries
long term
loan interest
rental space
and equip
depreciation
Taxable
$9,999,000
Tax Rate
22%
Sur Tax
26%
$6,999,000
$5,999,000
$5,499,000
$4,799,000
$4,199,000
$923,780 $1,091,740
Taxable income = $4,199,000
Income Tax = $4,199,00 * 22% = $923.780
Surtax = $4,199,000 * 26% = $1,091,740
2. A firm has invested $14,000 in machinery with a 7-year useful life. The machinery will have
no salvage value, as the cost to remove it will equal its scrap value. The uniform annual
benefits from the machinery are $3600. For a combined 47% income tax rate, and sum-ofyears’-digits depreciation, compute the after-tax rate of return (10 points).
Lowell D. Outland
IET310-301
Engineering Economics Analysis
14000
3600
7
0
0.47
first cost
annual benefit
recovery
period
salvage value
tax rate
year
Untaxed BTCF
0
1
2
3
4
5
6
7
($14,000)
Taxed BTCF
$3,600
$3,600
$3,600
$3,600
$3,600
$3,600
$3,600
SOYD
$3,500.00
$3,000.00
$2,500.00
$2,000.00
$1,500.00
$1,000.00
$500.00
Taxable
income
TAX
$100.00
-$47.00
$600.00
-$282.00
$1,100.00
-$517.00
$1,600.00
-$752.00
$2,100.00
-$987.00
$2,600.00 -$1,222.00
$3,100.00 -$1,457.00
after tax
cash flow
$14,000.00
$3,553.00
$3,318.00
$3,083.00
$2,848.00
$2,613.00
$2,378.00
$2,143.00
Before Tax Rate of Return = 17%
After Tax Rate of Return= 11%
3. Thomas Cotton is considering erecting a small building on a commercial lot. A local
furniture company is willing to lease the building for $9,000 per year, paid at the end of each
year. It is a net lease, which means the furniture company must also pay the property taxes,
fire insurance, and all other annual costs. The furniture company will require a 5-year lease
with an option to buy the building and land on which it stands for $125,000 after 5 years.
Thomas could have the building constructed for $82,000. He could sell the commercial lot
now for $30,000, the same price he paid for it. Thomas files a joint return and has an annual
taxable income from other sources of $63,900. He would depreciate the commercial building
by MACRS depreciation. Thomas believes that at end of 5-year lease he could easily sell the
property for $125,000. What is the after-tax present worth of this 5-year venture if Thomas
uses a 10% after-tax MARR (10 points)?
112000 first cost
30000 land +
82000 building
9000 annual benefit
5 recovery peroid
125000 salvage value
Lowell D. Outland
IET310-301
Engineering Economics Analysis
Year
Initial
annual
cost
benefits MACRS
0 $112,000
1
$9,000
2
$9,000
3
$9,000
4
$9,000
5 $125,000
$9,000
RECAP.
$16,400
$19,680
$11,808
$8,856
$8,856 $108,600
$65,600.00
Tax
Income
$7,400
$10,680
$2,808
$144
$233,744
TAX
$740
$1,068
$281
$14
$23,374
ATCF
$9,740
$10,068
$9,281
$8,986
$110,626
$148,700
After Tax Present Worth = $98,975.09
4. An engineer is being transferred to another state and must vacate her house. The house,
bought for $40,000 eight years ago, can be sold now for $60,000; the property is free of debt.
If the house is sold, she will have to pay a 15% capital gains tax. The engineer is also
considering leasing the house for five years, receiving $7,200 annual rental. In this case, she
estimates an annual disbursement of $1,800 for taxes, insurance and maintenance. She would
also be allowed $1,200 per year depreciation on her tax return (in addition to her cash
disbursements); her rental income would be taxed at 30%. (Note that houses cannot be
depreciated during the years used as the owner’s personal residence).
If she sells her house now she will have to pay 15% capital gains tax on $20,000 which would come
to $3,000, which would leave her with $57,000.
Determine her after-tax rate of return if she decides to lease the property and if the property shall be
worth $64,000 at the end of the lease (10 points).
Year
Initial
annual
Taxes
Tax
cost
benefits Depreciation
&Maint Income
TAX
ATCF
0
-40000
1
7200
1200
1800
4200
-1260
2
7200
1200
1800
4200
-1260
3
7200
1200
1800
4200
-1260
4
7200
1200
1800
4200
-1260
5
64000
7200
1200
1800
4200
-1260
64000
5940
5940
5940
5940
5940
29700
Lowell D. Outland
IET310-301
Engineering Economics Analysis
After tax rate of return =
53700
5. A small-business corporation is considering whether to replace some equipment in the plant. An
analysis indicates there are five alternatives in addition to the do-nothing option, Alternative A. The
alternatives have a 5-year useful life with no salvage value. Straight-line depreciation would be used.
Alternatives
Cost
($, thousands)
A
B
C
D
E
F
0
25
10
5
15
30
Before-Tax
Uniform
Annual
Benefits
(thousands)
0
7.5
3
1.7
5
8.7
Lowell D. Outland
IET310-301
Engineering Economics Analysis
The corporation has a combined federal and state income tax rate of 20%. If the corporation expects
a 10% after-tax rate of return for any new investments, which alternative should be selected (10
points)?
20%
income
tax
Proj
Initial
Annual
Taxable
B
cost
Benefits
Depreciation
Value
income
Year
0
$25,000
1
$7,500.00
-$5,000.00
$20,000
$2,500.00
$500.00
2
$7,500.00
-$5,000.00
$15,000
$2,500.00
$500.00
3
$7,500.00
-$5,000.00
$10,000
$2,500.00
$500.00
4
$7,500.00
-$5,000.00
$5,000
$2,500.00
$500.00
5
$7,500.00
-$5,000.00
$0
$2,500.00
$500.00
after tax rate of return
Proj
C
20%
Initial
Annual
Taxable
income
Year cost
Benefits
Depreciation
Value
income
tax
0
$10,000
1
$3,000
$2,000
$8,000
$1,000
$200
2
$3,000
$2,000
$6,000
$1,000
$200
3
$3,000
$2,000
$4,000
$1,000
$200
4
$3,000
$2,000
$2,000
$1,000
$200
5
$3,000
$2,000
$0
$1,000
$200
After tax rate of return
Proj.
D
20%
Initial
Annual
Taxable
income
Year cost
Benefits
Depreciation
Value
income
tax
0
$5,000
1
$1,700
$1,000
$4,000
$700
$140
2
$1,700
$1,000
$3,000
$700
$140
3
$1,700
$1,000
$2,000
$700
$140
4
$1,700
$1,000
$1,000
$700
$140
5
$1,700
$1,000
$0
$700
$140
After tax rate of return
Proj
E
20%
Initial
Annual
Taxable
income
Year cost
Benefits
Depreciation
Value
income
tax
after tax
cash flow
$25,000.00
$7,000.00
$7,000.00
$7,000.00
$7,000.00
$7,000.00
12.38%
after tax
cash flow
$10,000
$2,800
$2,800
$2,800
$2,800
$2,800
12.38%
after tax
cash flow
$5,000
$1,560
$1,560
$1,560
$1,560
$1,560
16.92%
after tax
cash flow
Lowell D. Outland
IET310-301
Engineering Economics Analysis
0
1
2
3
4
5
$15,000
$5,000
$5,000
$5,000
$5,000
$5,000
$3,000
$3,000
$3,000
$3,000
$3,000
$12,000
$9,000
$6,000
$3,000
$0
$2,000
$400
$2,000
$400
$2,000
$400
$2,000
$400
$2,000
$400
After tax rate of return
$15,000
$4,600
$4,600
$4,600
$4,600
$4,600
16.18%
Proj.
F
20%
Initial
Annual
Taxable
income
after tax
Year cost
Benefits
Depreciation
Value
income
tax
cash flow
0
$30,000
-$30,000
1
$8,700
$6,000
$24,000
$2,700
$540
$8,160
2
$8,700
$6,000
$18,000
$2,700
$540
$8,160
3
$8,700
$6,000
$12,000
$2,700
$540
$8,160
4
$8,700
$6,000
$6,000
$2,700
$540
$8,160
5
$8,700
$6,000
$0
$2,700
$540
$8,160
After tax rate of return
11.21%
All of the projects, with the exception of the do nothing concept (Project A), would give in excess of
the 10% Rate of Return that the company requires. That being said however, Project D would be the
one to select, having a rate of return of 16.92%.
Note – Units are important. If units are not present, 10% per problem will be deducted.
Lowell D. Outland
IET310-301
Engineering Economics Analysis