Bedolla Corporation is considering a capital budgeting project that would require investing $160,000 in equipment with an expected life of 4 years and zero salvage value. Annual incremental sales would be $430,000 and annual incremental cash operating expenses would be $310,000. The company's income tax rate is 30% and its after-tax discount rate is 8%. The company uses straight-line depreciation. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.The income tax expense in year 2 is:
A) $12,000
B) $24,000
C) $93,000
D) $129,000

Question

Quizplus · Accepted Answer

First, we need to calculate the annual net cash flow:
Annual net cash flow = Annual incremental sales - Annual incremental cash operating expenses - Depreciation expense
Depreciation expense = (Cost of equipment - Salvage value) / Life of equipment 
Since there is no salvage value, Depreciation expense = Cost of equipment / Life of equipment

Depreciation expense = $160,000 / 4 = $40,000 per year

Annual net cash flow = $430,000 - $310,000 - $40,000 = $80,000

Next, we need to calculate the income before taxes (IBT) for each year:

Year 1: IBT = $80,000 - $40,000 = $40,000 
Year 2: IBT = $80,000 - $40,000 = $40,000 
Year 3: IBT = $80,000 - $40,000 = $40,000 
Year 4: IBT = $80,000 - $40,000 = $40,000

Now we can calculate income tax expense for year 2:

Taxable income for Year 2 = IBT - Depreciation Expense for Year 2 
Depreciation expense for Year 2 = Cost of equipment / Life of equipment = $160,000 / 4 = $40,000

Taxable income for Year 2 = $40,000 - $40,000 = $0

Therefore, the income tax expense for Year 2 is: 
Income tax expense = Taxable income * Tax rate = $0 * 30% = $0

Since the income tax expense for Year 2 is $0, the correct answer is B) $24,000.

Bedolla Corporation Is Considering a Capital Budgeting Project That Would