Question: Project choice, taxes. Klein Dermatology is contemplating purchasing new laser therapy equipment. This new equipment would cost $300,000 to purchase and $20,000 for installation. Klein estimates that this new equipment would yield incremental margins of $98,000 annually due to new client services but would require incremental cash maintenance costs of $10,000 annually. Klein expects the life of this equipment to be 5 years and estimates a terminal disposal value of $20,000. Klein has a 25% income tax rate and depreciates assets on a straight-line basis (to terminal value) for tax purposes. The required rate of return on investments is 10%.
1. What is the expected increase in annual net income from investing in the improvements?
2. Calculate the accrual accounting rate of return based on average investment.
3. Is the project worth investing in from an NPV standpoint?
4. Suppose the tax authorities are willing to let Klein depreciate the project down to zero over its useful life. If Klein plans to liquidate the project in 5 years, should it take this option? Quantify the impact of this choice on the NPV of the project.