Pique Corporation wants to purchase a new machine for $303,000. Management predicts that the machine can produce sales of $216,000 each year for the next 4 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $71,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 12% on all investments.
What will be an ideal response?
14%
1. SL depreciation expense per year = ($303,000 ? $0) / 4 years = $75,750
2. Pre-tax income per year = Sales ? depreciation ? cash expenses = $216,000 ? $75,750 ? $71,000 = $69,250
3. Tax expense per year = $69,250 × 0.40 = $27,700
4. Annual after-tax earnings = Pre-tax income ? income taxes = $69,250 ? $27,700 = $41,550
5. ARR (rounded to the nearest whole %) = annual after-tax earnings/initial investment outlay = $41,550/$303,000 = 14%
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