Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $62,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $26,800. A new piece of equipment will cost $152,000. It also falls into the five-year category for MACRS depreciation. Assume the new equipment would provide the following stream of added cost savings for the next six years. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Year		Cash Savings
1		$	64,000
2			56,000
3			54,000
4			52,000
5			49,000
6			38,000

The firm’s tax rate is 30 percent and the cost of capital is 14 percent.

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $62,000. The equipment fails into the five-year category for MACRS depreciation and can currently be sold for $26.800. A new piece of equipment will cost $152,000. It also falls into the five-year category for MACRS depreciation. Assume the new equipment would provide the following stream of added cost savings for the next six years. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods Year 1 2 Savings S64000 6 000 The firm's tax rate is 30 percent and the cost of capital is 14 percent a. What is the book value of the old equipment? (Do not round Intermediate calculations an rest whole dollar) Book Value $ 29,760 b. What is the tax loss on the sale of the old equipment? (Do not round Intermediate calculations and round your answer to the nearest whole dollar) Taxoss $ 2980 c. What is the tax benefit from the sale(Do not round intermediate calculations and round your answer to the nearest whole dollar) Tax benett

Answer 1

Tax rate 30% Calculation of cash inflow from the sale of old equipment $ 52% Cost of the old asset MACARS depreciation for 2 years (20%+3 WDV Sale price Profit/(Loss) Tax Cash flow from sale after-tax $ 62,000 32,240 29,760 26,800 (2,960) (888) 27,688 $ $ $ Calculation of the net cost of new equipment Cost of the new equipment Cash flow from the sale of old equipment The net cost of new equipment $ $ $ 152,000 (27,688) 124,312 Calculation of annual depreciation-new machine Total Depreciation Cost Dep Rate Depreciation Year-1 Year-2 Year-3 Year-4 $ 152,000 $ 152,000 $ 152,000 $ 152,000 20.00% 32.00% 19.20% 11.50% $ 30,400 $ 48,640 $ 29,184 $ 17,480 Year-5 Year-6 $ 152,000 $ 152,000 11.50% 5.80% $ 17,480 $ 8,816 $ 152,000 Calculation of annual depreciation-old machine Total Depreciation Cost Dep Rate Depreciation Year-3 Year-4 Year-5 Year-6 $ 62,000 $ 62,000 $ 62,000 $ 62,000 19.20% 11.50% 11.50% 5.80% 11,904 $ 7,130 $ 7,130 $ 3,596 $ 1.20% 11.50% 1.5% $ 29,760

Calculation of incremental depreciation Depreciation Depreciation on new equipment Depreciation on old equipment Incremental depreciation Tax rate Tax shield Year-1 $ $ $ 30,400 11,904 18,496 30% 5,549 Year-2 $ 48,640 $ 7,130 $ 41,510 30% $ 12,453 Year-3 $ $ $ 29,184 7,130 22,054 30% 6,616 Year-4 $ $ $ 17,480 3,596 13,884 30% 4,165 Year-5 $ $ $ 17,480 - 17,480 30% 5,244 Year-6 $ $ $ 8,816 - 8,816 30% 2,645 Total $ $ $ 152,000 29,760 122,240 $ $ $ $ $ $ 36,672 Calculation of after-tax benefit of cost savings Year Tear-3 Year- 5 $ 311,000 cost saving (1-Tax rate) Tax shield Year-1 $ 64,000 70% $ 44,800 Year-2 Year-3 Year-4 $ 54,000 $ 54,000 $ 52,000 70% 70% 70% $ 37,800 $ 37,800 $ 36,400 Y ear-6 49,000 $ 70% 34,300 $ Total 38,000 $ 70% 26,600 $ $ 217,700 Calculation of total annual benefit Year Tax shield on depreciation After tax cost saving Total annual benefit Year-1 $ $ $ 5,549 44,800 50,349 Year-2 Year-3 $ 12,453 $ 6,616 $ 37,800 $ 37,800 $ 50,253 $ 44,416 Year-4 $ $ $ Year-5 Year-6 4,165 $ 5,244 $ 36,400 $ 34,300 $ 40,565 $ 39,544 $ Total 2,645 $ 26,600 $ 29,245 $ 36,672 217,700 254,372 Calculation of PV of total annual benefit Year-1 $ Year-3 $ Year-4 $ 254,372 Year Total annual benefit PV factor Total annual benefit* PV factor 50,349 0.877 44,166 Year-2 $ 50,253 0.769 $ 38,668 44,416 0.675 29,980 Year-5 Year-6 Total 40,565 $ 39,544 $ 29,245 $ 0.592 0.519 0.456 24,018 $ 20,538 $ 13,324 $ $ $ $ 170,693

Calculation of PV of total annual benefit net with initial cost PV of total annual benefit Initial cash flow NPV of replacement $ $ $ 170,693 (124,312) 46,381 Final decision Since NPV is positive, replacement should be undertaken.