Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $76,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $33,800. A new plece of equipment will cost $150,000. 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 Cash Savings $60,000 50,000 48,000 46,000 43,000 32,000 6 The firm's tax rate is 25 percent and the cost of capital is 14 percent.

Answer 1

Answer to first 4 parts of the question:

Year Old equipment's 5-year MACRS table (a) (b) (a) (b) Dep. % Cost Annual Dep. Book Value 20.00% $76,000 $15,200 $60,800 [$76000 - $15200] 32.00% $76,000 $24,320 $36,480 ($60800 - $24320] 19.20% $76,000 $14,592 $21,888 ($36480 - $14592] 11.52% $76,000 $8,755 $13,133 [$21888 - $8755] 11.52% $76,000 $8,755 $4,378 ($13133 - $8755] 5.76% $76,000 $4,378 $0 [$4378 - $4378] Therefore, Book value of the old equipment today (2 years later) Sale value of the old equipment today (2 years later) Loss on sale of old equipment today Tax rate Tax benefit on loss on sale of old equipment $36,480 [Ref: MACRS table presented above] $33,800 $2,680 ($36480 - $33800] 25% $670 ($2680 x 25% --> It is equal to a cash inflow] Cost of the new equipment today After-tax net proceeds from sale of old equipment today Net cost incurred today to purchase new equipment $150,000 $34,470 ($33800 + $670 --> Tax credit is added to sale value] -$115,530 [-$150000 + $34470]

f) New equipment's 5-year MACRS table Year Dep. Base Dep. % Annual Dep. $150,000 20.00% $30,000 ($150000 x 20.00%] $150,000 32.00% $48,000 ($150000 x 32.00%] 3 $150,000 19.20% $28,800 ($150000 x 19.20%] $150,000 11.52% $17,280 ($150000 x 11.52%] $150,000 11.52% $17,280 ($150000 x 11.52%] $150,000 5.76% $8,640 ($150000 x 5.76%] $ 150,000 Nm tin g) Old equipment's 5-year MACRS table (for bal. yrs.) Year Dep. Base Dep. % Annual Dep. $76,000 19.20% $14,592 [$76000 x 19.2.00%] $76,000 11.52% $8,755 [$76000 x 11.52.00%] $76,000 11.52% $8,755 ($76000 x 11.520%] $76,000 5.76% $4,378 ($76000 x 5.76%]

h) (r) x (s) Tax Shield Benefits Year Incremental depreciation schedule (p) (q) ()=(q) - (p) (s) Dep. On Dep. On Incremental New Tax Rate Old Equip. Dep. Equip. $30,000 $14,592 $15,408 25% $48,000 $8,755 $39,245 25% $28,800 $8,755 $20,045 25% $17,280 $4,378 $12,902 25% $17,280 $17,280 25% $8,640 $0 $8,640 25% $3,852 $9,811 $5,011 $3,226 $4,320 $2,160 $o