Question

Mideque, Inc., is considering a project to produce pens. Assume that this is a replacement project. The old equipment can be sold for $10,762 as of today. It was bought five years ago for $22,251 and is assumed to last for five more years with no salvage value at the end of its life. The initial cost of the new equipment, including transportation, installation, and so forth, will be $ 23,081. Mideque also estimates that this new equipment will save the company $3,482 per year in operating costs and increase the revenues (sales) by $1,076 per year over the five-year life of the project. Mideque will finance $9,141 by loan with an interest rate of 12 percent per year. The loan will be repaid at the rate of $2,555 per year plus interest on the remaining balance each year. Mideque uses straight-line depreciation, and the new equipment will have no salvage value at the end of its 5-year life. Assume a corporate-profits tax rate of 44 percent a capital-gain tax rate of 41 percent. Compute the initial investment.

Answer 1

first let us know the after tax salvage value of old equipment:

book value = ($22,251 /10 years life * 5 years) =>11,125.5

book value	11,125.50
less:sale value	(10,762)
loss	(363.50)
tax savings on loss (363.50*41%)	149.035

now,

initial investment:

initial cost	23,081
less: sale value	(10,762)
less: tax savings	(149.035)
initial investment	$12,169.96