Question

Xon, a small oil equipment company, purchased a new petroleum drilling rig for $2,000,000. xon will depreciate it using macrs depreciation. the drilling rig has been leased to a firm, which will pay xon $750,000 per year for 8 years. after 8 years the drilling rig will belong to the firm. xon has a 28% combined incremental tax rate and a 20% after-tax marr.

does the investment appear to be satisfactory?

Answer 1

To determine if the investment is satisfactory, calculate the present value of the cash flows and compare it to the initial cost. In this case, the present value is greater than the initial cost, indicating a satisfactory investment.

Step-by-step explanation:

To determine if the investment is satisfactory, we need to calculate the present value of the cash flows generated by the drilling rig and compare it to the initial cost. Given that the drilling rig is leased for 8 years with an annual payment of $750,000, we can calculate the present value using the formula:

Present Value = Payment / (1 + r)^n

Where r is the discount rate and n is the number of years. Since the after-tax MARR is 20%, the discount rate will be 1 - 0.2 = 0.8. Plugging in the numbers, we get:

Present Value = $750,000 / (1 + 0.8)^8 = $750,000 / 3.058^8 = $1,02,512.71

The present value of the cash flows is greater than the initial cost of $2,000,000, meaning that the investment appears to be satisfactory.

Answer 2

To evaluate the satisfaction of Xon's investment in a petroleum drilling rig, we calculate the after-tax cash flow from annual lease payments and compare the NPV to the initial cost, considering a 28% tax rate and a 20% after-tax MARR.

Step-by-step explanation:

To determine if the investment for Xon, a small oil equipment company, in a new petroleum drilling rig is satisfactory, we need to analyze the cash flows and the return on investment considering the given financial details such as the cost of the rig, the annual lease revenue, the Macrs depreciation method, the tax rate, and the minimum attractive rate of return (MARR). The company will depreciate the $2,000,000 drilling rig using MACRS and earn $750,000 per annum for 8 years. With a 28% tax rate, the after-tax cash flow can be calculated each year after accounting for depreciation and tax on the lease revenue. The net present value (NPV) of these cash flows should be compared to the initial investment to determine if the investment yields a satisfactory return above the 20% after-tax MARR.