Question

Middlefield Motors is evaluating project A, which would require the purchase of a piece of equipment for $332,000. During year 1, project A is expected to have relevant revenue of $180,000, relevant costs of $66,000, and some depreciation. Middlefield Motors would need to borrow $332,000 for the equipment and would need to make an interest payment of $26,560 to the bank in year 1. Relevant net income for project A in year 1 is expected to be $37,000, and operating cash flows for project A in year 1 are expected to be $96,000. Straight-line depreciation would be used. What is the tax rate expected to be in year 1? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

To determine the tax rate for project A in year 1 for Middlefield Motors, we analyzed the financial data and calculated that the tax rate would effectively be 0% because the cash tax paid is $0 despite a positive taxable income.

Step-by-step explanation:

To find the tax rate for Middlefield Motors in year 1, we need to analyze the given financial data for project A. We know that operating cash flows are reported as $96,000, but this includes depreciation, which is a non-cash charge. We must add back depreciation to net income to get operating cash flows. Therefore, we can calculate depreciation using the formula:

Operating Cash Flows = Net Income + Depreciation

We have Operating Cash Flows ($96,000) and Net Income ($37,000), and we can solve for Depreciation:

$96,000 = $37,000 + Depreciation

Depreciation = $59,000

To calculate the tax paid, we can use the interest payment given, because the interest is tax-deductible. We adjust the net income before taxes by adding back the interest payment:

Taxable Income = Net Income + Interest Payment + Depreciation

Taxable Income = $37,000 + $26,560 + $59,000

Taxable Income = $122,560

Knowing the Operating Cash Flows, we can now calculate the cash tax paid:

Cash Tax Paid = Operating Cash Flows - (Net Income + Depreciation)

Cash Tax Paid = $96,000 - ($37,000 + $59,000)

Cash Tax Paid = $0

Since the cash tax paid is $0 and we have a positive taxable income figure, it indicates that the tax rate is 0%, meaning there is no tax burden for this project in year 1.