Question

the shellout corp. owns a piece of petroleum drilling equipment that costs $300,000 and will be depreciated over 10 years by double declining balance depreciation. there is a combined 30% tax rate. shellout will lease the equipment to others and each year receive $165,000 in rent. at the end of 5 years, the firm will sell the equipment for $80,000. what is the after-tax rate of return shellout will receive from this equipment investment?

Answer 1

The after-tax rate of return Shellout will receive from this equipment investment is -40.71%.

Step-by-step explanation:

To calculate the after-tax rate of return, we need to calculate the net cash flows for each year and then calculate the present value of those cash flows using the after-tax discount rate.

1. Calculate the annual depreciation expense using the double declining balance method:

Depreciation expense = (2 / n) * Book value at the beginning of the year

For year 1, depreciation expense = (2 / 10) * $300,000 = $60,000

1. Calculate the net operating income for each year:

Net operating income = Rent - Depreciation expense

For year 1, net operating income = $165,000 - $60,000 = $105,000

1. Calculate the net cash flow for each year:

Net cash flow = Net operating income - Tax

For year 1, tax = ($165,000 - $60,000) * 30% = $31,500

Net cash flow = $105,000 - $31,500 = $73,500

1. Calculate the present value of each net cash flow:

Present value = Net cash flow / (1 + Discount rate)n

For year 1, present value = $73,500 / (1 + 30%) = $56,538.46

1. Sum up the present values of all net cash flows:

PVtotal = $56,538.46 + PVyear 2 + PVyear 3 + PVyear 4 + PVyear 5

1. Calculate the after-tax rate of return:

After-tax rate of return = (PVtotal - Initial investment) / Initial investment * 100%

Initial investment = Cost of equipment - Salvage value = $300,000 - $80,000 = $220,000

After-tax rate of return = ($56,538.46 - $220,000) / $220,000 * 100% = -40.71%