Our company must replace an obsolete machine press. We have two bids that are su
ID: 1101155 • Letter: O
Question
Our company must replace an obsolete machine press. We have two bids that are summarized below. Both of the presses fall into the MACRS 5 year property classification. Our company uses an after tax MARR of 8% and MACRS depreciation. Our company falls into the 38% total income tax bracket. The machines are sold at the end of 6 years for their salvage value shown in the table below. Select the most economical alternative based on the after-tax cash flow.
Our company has the option of selling Machine A for $30,000 at the end of year 4. Does this change your choice? Make sure to support your answer.Explanation / Answer
with MACRS 5 yr depreciation method various percentage depreciation are given in respective years
(ie 20 % in 1st yr 32 in second, 19.2 in 3rd ,11.2 in 4rth and 5th,5.76 in 6th)
let initial cost be P which is 60000 for A and 76000 for B
in 1 st yr deprciation = 20 % of initial cost = 0.2P ie 12000 for A and 15200 for B
FOR A tax will be on 16,500-3000-12000 =1500
hence tax = 0.38 *1500 =570
hence 1st yr income FOR A =16500-3000 -570 =12930
FOR B
tax will be on 25000-3500-15200 =6300
hence tax = 0.38 *6300 =2394
hence 1st yr income FOR B =25000-3500 -2394 =19106
in 2 st yr deprciation = 32 % of initial cost = 0.32P ie `19200 for A and 24320 for B
FOR A tax will be on 16,500-3000-19200 =0
hence tax = 0.38 *0 =0
hence 2nd yr income FOR A =16500-3000 =13500
FOR B
tax will be on 25000-3500-24320 =0
hence tax = 0.38 *0 =0
hence 2nd yr income FOR B =25000-3500 =21500
in 3 st yr deprciation = 19.2 % of initial cost = 0.192P hence for A =11520 and for B =14592
FOR A tax will be on 16,500-3000-11520 =1980
hence tax = 0.38 *1980 =752.4
hence 3st yr income FOR A =16500-3000 -752.4 =12747.6
FOR B
tax will be on 25000-3500-14592 =6908
hence tax = 0.38 *6908 =2625
hence 3rd yr income FOR B =25000-3500 -2625 =18875
in 4 yr deprciation = 11.52 % of initial cost = 0.1152P hence for A =6900 and for B =8740
FOR A tax will be on 16,500-3000-6900 =6600
hence tax = 0.38 *6600 =2508
hence 4st yr income FOR A =16500-3000 -2508 =10992
FOR B
tax will be on 25000-3500-8740 =12760
hence tax = 0.38 *12760 =4848.8
hence 4rth yr income FOR B =25000-3500 -4848.8 =16651
in 5 st yr deprciation = 11.52 % of initial cost = 0.11.52P hence for A =6900 and for B =8740
FOR A tax will be on 16,500-3000-6900 =6600
hence tax = 0.38 *6600 =2508
hence 5th yr income FOR A =16500-3000 -2508 =10992
FOR B
tax will be on 25000-3500-8740 =12760
hence tax = 0.38 *12760 =4848.8
hence 5th yr income FOR B =25000-3500 -4848.8 =16651
in 6 st yr deprciation (this is done on salvage value) = 5.76 % of initial cost = 0.0576P hence for A =3450 and for B =4370
hence before tax income for salvage for A =3500-3450 =50
tax =0.38*50 =19
income =3500-19 =3481
before tax income for salvage for B =6000-4370 =1630
tax for B =0.38*1630 =619.4
income for B=6000 -619.4 =5380.6
..................................
now we will calculate present value for the analyis MARR =8% =0.08
present value of A =12930/1.08 +13500/1.08^2 +12747.6/1.08^3 +10992/1.08^4 +10992/1.08^5 +3481/1.08^6 -60000
= -8580
...........
present value of B =19106/1.08 +21500/1.08^2 +18875/1.08^3 +16651/1.08^4 +16651/1.08^5 +5380.6/1.08^6 -76000
=2069
hence after tax analysis shows B is more profitable
..........
if A is sold at the end of 4rth yr then with 30000
then remaining 11.52 and 5.76 percent will come in this depreciation
ie 17.28*60000 =10368
before tax =30000 -10368 =19632
tax =0.38 *19632 =7460.16
income =30000 -7460.16 =22539.84
present value of A =12930/1.08 +13500/1.08^2 +12747.6/1.08^3 +10992/1.08^4 +22539.84/1.08^5 -60000
=-2915
...
hence this does not change my choice of selecting B
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