After-Tax Analysis of an Integrated Circuit Production Line
The Ajax Semiconductor Company is attempting to evaluate the profitability of adding another integrated circuit production line to its present operations. The company would need to purchase two or more acres of land for $275,000 (total). The facility would cost $60,000,000 and have no net MV at the end of five years. The facility could be depreciated using a GDS recovery period of five years. An increment of working capital would be required, and its estimated amount is $10,000,000. Gross income is expected to increase by $30,000,000 per year for five years, and operating expenses are estimated to be $8,000,000 per year for five years The firm’s effective income tax rate is 40%.
(a) Set up a table and determine the ATCF for this project.
(b) Is the investment worthwhile when the after-tax MARR is 12% per year?
Question 7.18: After-Tax Analysis of an Integrated Circuit Production Line ...
TABLE 7-8
After-Tax Analysis of Example 7-18
| End of Year, k | ( A) | ( B) | ( C) = ( A)−( B) | ( D) = −0.4( C) | ( E) = ( A) + ( D) |
| BTCF | Depreciation Deduction | Taxable Income | Cash Flow for Income Taxes | ATCF | |
| 0 | \begin{cases} −\$60,000,0000 \\ −10,000,000 \\ −275,000 \end{cases} | -$70,275,000 | |||
| 1 | 22,000,000 | $12,000,000 | $10,000,000 | −$4,000,000 | 18,000,000 |
| 2 | 22,000,000 | 19,200,000 | 2,800,000 | − 1,120,000 | 20,880,000 |
| 3 | 22,000,000 | 11,520,000 | 10,480,000 | − 4,192,000 | 17,808,000 |
| 4 | 22,000,000 | 6,912,000 | 15,088,000 | − 6,035,200 | 15,964,800 |
| 5 | 22,000,000 | 3,456,000 | 18,544,000 | − 7,417,600 | 14,582,400 |
| 5 | 10,275,000^{a} | − 6,912,000^{b} | 2,764,800^{b} | 13,039,800 | |
^{a} MV of working capital and land.
^{b} Because BV_{5} of the production facility is $6,912,000 and net MV_{5} =0, a loss on disposal would be taken at EOY 5.
(a) The format recommended in Figure 7-5 is followed in Table 7-8 to obtain ATCFs in years zero through five. Acquisitions of land, as well as additional working capital, are treated as nondepreciable capital investments whose MVs at the end of year five are estimated to equal their first costs. (In economic evaluations, it is customary to assume that land and working capital do not inflate in value during the study period because they are “nonwasting” assets.) By using a variation of Equation (7-21), we are able to compute ATCF in year three (for example) to be
ATCF _{3} = ($30,000,000 − $8,000,000 − $11,520,000)(1 − 0.40) + $11,520,000 = $17,808,000.
(7-21)
ATCF_k=(1-t)\left(R_{k}-E_{k}\right)+t d_{k}
(b) The depreciable property in Example 7-18 ($60,000,000) will be disposed of for $0 at the end of year five, and a loss on disposal of $6,912,000 will be claimed at the end of year five. Only a half-year of depreciation ($3,456,000) can be claimed as a deduction in year five, and the BV is $6,912,900 at the end of year five. Because the selling price (MV) is zero, the loss on disposal equals our BV of $6,912,000. As seen from Figure 7-5, a tax credit of 0.40($6,912,000) = $2,764,800 is created at the end of year five. The after-tax IRR is obtained from entries in column E of Table 7-8 and is found to be 12.5%. The after-tax PW equals $936,715 at MARR = 12% per year. Based on economic considerations, this integrated circuit production line should be recommended because it appears to be quite attractive.
