Question:
Chicago Hydraulic is considering an investment in computer-based production technology as part of a business reengineering process. The necessary equipment, installation, and training will cost $40,000,000, have a life of eight years, and generate annual net before tax cash flows from operations of $8,400,000. The technology will have no value at the end of its eight-year estimated life. The company's tax rate is 30 percent, and its cost of capital is 8 percent.
a. If Chicago Hydraulic uses straight-line depreciation for tax purposes, is the project acceptable using the net present value method? (continued)
b. Assume the tax law allows the company to take accelerated annual depreciation on this asset in the following manner:
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Years 1-2
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23 percent of cost
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Years 3-8
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9 percent of cost
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What is the net present value of the project? Is it acceptable?
c. Recompute parts (a) and (b), assuming the tax rate is increased to 50 percent.