High Tech Production Inc. purchased a computerized measuring device two years ago for $80,000. This equipment falls into the five-year category for MACRS depreciation. The equipment can currently be sold for $28,400. A new piece of equipment will cost $210,000 that would replace the exisitng equipment. It also falls into the five-year category for MACRS depreciation. It is anticipated this new piece of equipment will be sold at the end of the 5th year of operation for a price of $20,000. The tax rate is 34 percent and the cost of capital is 12 percent.
The new equipment would provide the following stream of operating cost savings before depreciation and taxes for the next five years.
|
Year
|
Cost Savings
|
|
1
|
$76,000
|
|
2
|
66,000
|
|
3
|
62,000
|
|
4
|
60,000
|
|
5
|
56,000
|
- Determine the depreciation schedule for the old equipment.
- What is the book value of the old equipment?
- What is the tax gain or loss on the sale of the old equipment?
- What is the tax or the tax benefit from the sale?
- What is the cash inflow from the sale of the old equipment?
- What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)
- Determine the depreciation schedule for the new equipment.
- What will be the book value of the new piece of equipment when it comes time to sell it, and what will be the tax gain or loss on the sale of the new equipment?
- What will be the tax or the tax benefit from the sale and the net cash inflow from the sale of the new equipment?
- What is the present value of the net cash inflow from the salvage of the new equipment?
- Determine the incremental depreciation between the new equipment the remaining years of the old equipment, and the related tax shield benefits.
- Compute the after-tax benefits of the cost savings.
- Add the depreciation tax shield benefits and the after-tax cost savings, and determine the present value of these incremental benefits. (See Table 12-17 in Chapter 12 of the text as an example.)
- Compare the present value of the incremental benefits (m), plus the present value of the expected proceeds from the salvage of the new machine (j) with the net cost of the new machine (f).
- Should the replacement be undertaken?