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suppose an asset has a first cost of 6 000 a life of five years a salvage value of 2 671260

Generalized Cash Flow Method

Suppose an asset has a first cost of $6,000, a life of five years, a salvage value of $2,000 at the end of five years, and a net annual before tax revenue of $1,500. The firm’s marginal tax rate is 35%. The asset will be depreciated by three year MACRS.

(a) Using the generalized cash flow approach, determine the cash flow after taxes.

(b) Rework part (a), assuming that the entire investment would be financed by a bank loan at an interest rate of 9%.

(c) Given a choice between the financing methods of parts (a) and (b), show calculations to justify your choice of which is the better one at an interest rate of 9%.

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