A firm is concerned about the condition of some of its plant machinery. Bill Jam

Question

A firm is concerned about the condition of some of its plant machinery. Bill James, a newly hired engineer, reviewed the situation and identified five feasible, mutually exclusive alternatives. Alternative A: Spend $44,000 now repairing various items. The $44,000 can be charged as a current operating expense (rather than capitalized) and deducted from other taxable income immediately. These repairs will keep the plant functioning for 7 years with current operating costs. Alternative B: Spend $49,000 to buy general-purpose equipment. Depreciation would be straight line over the equipment's 7-year useful life. The equipment has no salvage value. The new equipment will reduce annual operating costs by $6000. Alternative C: Spend $56,000 to buy new specialized equipment. This equipment would be depreciated by sum-of-years' -digits depreciation over its 7-year useful life. This equipment would reduce annual operating costs by $12,000. It will have no salvage value. Alternative D: This alternative is the same as Alternative B, except it reduces annual operating costs by $7000. Alternative E: This is the "do nothing" alternative, with annual operating costs $8000 above the present level. This profitable firm pays 40% corporate income taxes and uses a 10% after-tax rate of return. Which alternative should the firm adopt?

Explanation / Answer

alternative C is more profitable among these.

the total investment is $56,000, its annual depreciation is 56000/7= $8000

and the benefits are worth of $12000

even if we consider the cost of capital 10%, the total benefits are more than total costs. so, alternative C is better

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