PROBLEM 13C-5 Income Taxes and
Shimano Company has an opportunity to manufacture and sell one of two new products for a fiveyear period. The company’s tax rate is 30% and its after-tax cost of capital is 14%. The cost and revenue estimates for each product are as follows:
Product A Product B
Initial Investment in equipment…………….......................... $400,000 $550,000
Initial investment in
Annual sales …………………………………………………. $370,000 $390,000
Annual cash operating expenses…………………………….. $200,000 $170,000
Cost of repairs needed in three years………………………... $45,000 $70,000
The equipment pertaining to both products has a useful life of five years and no salvage value. The company uses the
Required:
- Calculate the annual income tax expense for each of years 1 through 5 that will arise if Product A is introduced.
- Calculate the net present value of the investment opportunity pertaining to Product A.
- Calculate the annual income tax expense for each of years 1 through 5 that will arise if Product B is intoduced.
- Calculate the net present value of the investment opportunity pertaining to Product B.
- Calculate the project profitability index for Product A and Product B. Which of the two products should the company purses? Why?
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