Essay: Analysis of Investing in New Laser Therapy Equipment for Markers Tattoo Studio
Introduction
Markers Tattoo Studio is considering investing in new laser therapy equipment to enhance their services and attract more clients. This essay will provide a comprehensive financial analysis to determine the feasibility of this investment. We will calculate the expected increase in annual net income, the accrual accounting rate of return, and evaluate the investment’s net present value (NPV). Additionally, we will explore the impact of different depreciation methods on the NPV of the new equipment.
Expected Increase in Annual Net Income
To calculate the expected increase in annual net income, we need to consider the incremental margins generated by the new equipment and the cash maintenance costs associated with it. The incremental margin is $98,000 annually, while the incremental cash maintenance costs amount to $10,000 per year. Therefore, the expected increase in annual net income can be calculated as follows:
Expected Increase in Annual Net Income = Incremental Margins – Cash Maintenance Costs
Expected Increase in Annual Net Income = $98,000 – $10,000
Expected Increase in Annual Net Income = $88,000
Therefore, Markers Tattoo Studio can expect an annual increase in net income of $88,000 by investing in the new laser therapy equipment.
Accrual Accounting Rate of Return
The accrual accounting rate of return is a measure used to evaluate the profitability of an investment based on average investment. It is calculated by dividing the average annual accounting profit by the average investment. The average investment is calculated as the initial investment plus the terminal disposal value divided by 2.
Average Investment = (Initial Investment + Terminal Disposal Value) / 2
Average Investment = ($300,000 + $20,000) / 2
Average Investment = $160,000
Therefore, the accrual accounting rate of return can be calculated as follows:
Accrual Accounting Rate of Return = Expected Increase in Annual Net Income / Average Investment
Accrual Accounting Rate of Return = $88,000 / $160,000
Accrual Accounting Rate of Return = 0.55 or 55%
Net Present Value Analysis
To determine whether the new equipment is worth investing in from a net present value standpoint, we need to calculate the NPV of the investment. The NPV is calculated by discounting the expected cash flows generated by the investment back to their present value using the required rate of return on investments.
The cash flows considered for NPV calculation include the incremental margins, cash maintenance costs, and terminal disposal value.
NPV = (Incremental Margins – Cash Maintenance Costs) / (1 + Required Rate of Return) + Terminal Disposal Value / (1 + Required Rate of Return)^5 – Initial Investment – Installation Costs
NPV = ($98,000 – $10,000) / (1 + 0.10) + $20,000 / (1 + 0.10)^5 – $300,000 – $20,000
NPV = $73,636.36 + $13,396.69 – $300,000 – $20,000
NPV = -$232,966.95
The negative NPV indicates that the investment in new laser therapy equipment may not be financially viable for Markers Tattoo Studio.
Impact of Depreciation Method on NPV
If Markers plans to liquidate the equipment in 5 years and the tax authorities allow depreciating the equipment down to zero over its useful life, it would be beneficial to choose this option. By depreciating the equipment to zero, Markers can reduce taxable income over time and potentially lower tax liabilities.
The impact of this choice on the NPV can be quantified by recalculating the NPV with depreciation down to zero allowed over the useful life. This change may result in a positive NPV or a less negative NPV, making the investment more attractive from a financial standpoint.
In conclusion, investing in new laser therapy equipment for Markers Tattoo Studio may not be financially advantageous based on the calculated NPV. However, choosing an optimal depreciation method that maximizes tax benefits can potentially improve the financial feasibility of this investment.
Investing in new laser therapy equipment should be a strategic decision that considers both financial aspects and operational benefits to ensure long-term success for Markers Tattoo Studio.
