Earnings pretax

A company is considering which of two plants to build. Both plants cost 25,000,000. They will each earn pretax profits of 7,000,000 a year after 5 years of operation. The pretax profits (these do not include any depreciation expenses) of each plant are as follows ... 

Interest. The iaterest block on Eigure 1 represents the iaterest expense associated with the debt capital. It is an allowed corporate pretax expense for federal income tax purposes and is actually paid out to the debt holders as their earnings. 

The two indicators used in Example 10-5 give different answers. The Proceeds per Dollar of Outlay procedure is obviously wrong. It would take 12.5 years to pay off the investment for plant 1. If the 15,000,000 pretax profit available at the end of year 4 were invested at 7% interest, the accumulated interest would have exceeded 10,800,000 before plant 1 was paid for. In other words, the total profit for plant 1 would exceed 25,800,000 before plant 2 showed a profit. This is more than the total profit made by plant 2 during its whole life. If the 15,000,000 profit of plant 1 were invested for 21 years at 7% compounded annually, the total interest would amount to 47,100,000 or the total earnings would be 62,100,000. If after plant 2 were paid off die profits were invested at 7% per year, the interest would amount to 8,900,000 or a total pretax profit of 33900,000 25 years after the plant startup. This is 28,200,000 less than that earned in the same amount of time by plant 1. This shows that for this example the Annual Proceeds per Dollar of Outlay is a better economic indicator. 

To estimate the cash flow for a particular year of plant operation, the pretax earnings are computed from Eq. (17.4) and the after-tax earnings from Eq. (17.5). However, in the calculation of the production cost, a more elaborate depreciation schedule, discussed in the next section, replaces the straight-line depreciation used in Section 17.2. The cash flow from plant operations is the after-tax earnings plus the depreciation ... 

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