Mulford Corporation has provided the following information concerning a capital budgeting project: The company's income tax rate is 30% and its after-tax discount rate is 12%. The working capital would be required immediately and would be released for use elsewhere at the end of the project. The company uses straight-line depreciation on all equipment. 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) $6,000
B) $9,000
C) $15,000
D) $3,000

Question

Mulford Corporation has provided the following information concerning a capital budgeting project:  The company's income tax rate is 30% and its after-tax discount rate is 12%. The working capital would be required immediately and would be released for use elsewhere at the end of the project. The company uses straight-line depreciation on all equipment. 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) $6,000 
B) $9,000 
C) $15,000 
D) $3,000

Quizplus · Accepted Answer

To calculate the income tax expense in year 2, we need to first calculate the taxable income for year 2.

Year 2's cash inflows would be $20,000 ($10,000 from operations and $10,000 from disposal of equipment). Its cash outflows would be $7,000 in operating expenses and $4,000 in depreciation expense ($20,000 / 5 years). This results in a taxable income of $9,000 ($20,000 - $7,000 - $4,000).

Applying the income tax rate of 30%, the income tax expense in year 2 would be $2,700 ($9,000 x 30%). However, we also need to consider the tax shield from depreciation. Since the company uses straight-line depreciation, the depreciation expense in year 2 would provide a tax shield of $1,200 ($4,000 x 30%).

Therefore, the net income tax expense in year 2 would be $4,500 ($2,700 - $1,200).

Mulford Corporation Has Provided the Following Information Concerning a Capital