A division of Raytheon owns a 5-year-old turret lathe used to manufacture fabric

Question

A division of Raytheon owns a 5-year-old turret lathe used to manufacture fabricated metal products that was purchased for $96,000 and now has a financial reporting (non-tax) book value of $24,000. It has been depreciated for tax purposes as MACRS-GDS 7-year property. It has a current market value of $18,000. The expected decline in market value is $3,000 per year from this point forward to a minimum of $3,000. O&M costs are $8,000 per year. Additional capability is needed. If the old lathe is kept, that new capability will be contracted out for $13,000, assumed payable at the end of each year. A new turret lathe has the increased capability to fulfill all needs, replacing the existing turret lathe and requiring no outside contracting. It can be purchased for $65,000 and will have an expected life of 8 years. Its market value is expected to be $65,000(0.7t) at the end of year t. Annual O&M costs are expected to equal $10,000. If the after-tax MARR is 9 percent, the tax rate is 40 percent, and the planning horizon is 8 years, determine whether to keep and use a contractor or to sell and buy new.

Explanation / Answer

MACRS 7 years rates Initial value 96000 Recovery year 7 year Dept. Amount Tax vaue current 21417.60 1 14.29 13718.40 2 24.49 23510.40 Cash flow(contracting) 3 17.49 16790.40 year 0 1 2 3 4 5 6 7 8 4 12.49 11990.40 O & M costs 8000.00 8000.00 8000.00 000.00 8000.00 8000.00 8000.00 8000.00 5 8.93 8572.80 Contracting costs 13000.00 13000.00 13000.00 13000.00 13000.00 13000.00 13000.00 13000.00 6 8.92 8563.20 Depreciation 8563.20 8572.80 4281.60 7 8.93 8572.80 Total costs 29563.20 29572.80 2521.60 21000.00 21000.00 21000.00 21000.00 21000.00 8 4.46 4281.60 Tax saving @ 40% 11825.28 11829.12 10112.64 8400 8400 8400 8400 8400 Less:Depreciation 8563.20 8572.80 4281.60 0.00 0.00 0.00 0.00 0.00 Less:salvage value 3000 Net outward cash flow(costs) -9174.72 9170.8 1087.36 12600.00 12600.00 12600.00 12600.00 9600.00 Initial value 65000 NPV @ 9% $60,881.97 Recovery year 7 year Dept. amount Salvage value at the end of 8 years 3747.121 (65000*0.7^8) 1 14.29 928.50 Cash flow(buying) 2 24.49 15918.50 year 0 1 2 3 4 5 6 7 8 3 17.49 11368.50 O&M Costs 10000.00 10000.00 10000.00 1000.00 10000.00 10000.00 10000.00 10000.00 4 8.93 5804.50 Depreciation 9288.50 15918.50 11368.50 8118.50 5804.50 5798.00 5804.50 2899.00 5 12.49 8118.50 Contracting costs 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 6 8.92 5798.00 Total costs 19288.50 25918.50 21368.50 1811.50 15804.50 15798.00 15804.50 12899.00 7 8.93 5804.50 Tax saving@40% 7715.4 10367.4 8547.4 7247.4 6321.8 6319.2 6321.8 5159.6 8 4.46 2899.00 Less:Depreciation 9288.50 15918.50 11368.50 8118.50 5804.50 5798.00 5804.50 2899.00 Less:gain on sale of old turrent 19367.04 Less:salvage value 3747.121 Add;tax 1498.848 Sale of old lathe 18000.00 Add:new lathe 65000.00 Tax value 21417.60 Net outward cash flow(costs) 45632.96 2284.6 -367.4 1452.6 2752.6 3678.2 3680.8 3678.2 2592.128 Loss -3417.60 Tax saving 1367.04 NPV @9% $58,389.70 Total gain 19367.04

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