Chevron Phillips (CP) has put into place new laboratory equipment for the production of chemicals; the cost is $1,770,000 installed. CP borrows 48% of all capital needed, and the borrowing rate is 13.4%. In the 1st year, 25% of the principal borrowed will be paid back. The throughput rate for in-process test samples has increased the capacity of the lab, saving a net of $X per year. In this 1st year, depreciation is $362,000 and taxable income is $329,000. Required:
a. What is the gross income or annual savings?
b. Determine the income tax for the 1st year assuming a marginal tax rate of 40%.
c. What is the after-tax cash flow for the 1st year?

Chevron Phillips (CP)

a. The gross income or annual savings is:

= $804,846.

b. The income tax for the 1st year assuming a marginal tax rate of 40% is:

= $131,600.

c. The after-tax cash flow for the 1st year is:

= $559,400.

Explanation:

a) Data and Calculations;

Cost of new laboratory equipment = $1,770,000

Borrowed capital = $849,600 ($1,770,000 * 48%)

Borrowing rate = 13.4%

Borrowing interest expense for the first year = $113,846

Depreciation = $362,000

Taxable income = $329,000

Gross savings = $X

$X = $804,846 ($113,846 + $362,000 + $329,000)

Income tax for the 1st year:

Marginal tax rate = 40%

Taxable income = $329,000

= $131,600 ($329,000 * 40%)

After-tax Cash Flows for the 1st year:

Gross savings =    $804,846

Interest expense      113,846

Depreciation          362,000

Taxable income  $329,000

Income tax              131,600

Net income          $197,400

Cash Flows:

Net income               $197,400

Depreciation             362,000

After-tax cash flow $559,400