Gluon Inc. is considering the purchase of a new high pressure glueball. It can p

Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $160,000 and sell its old low-pressure glueball, which is fully depreciated, for $28,000. The new equipment has a 10-year useful life and will save $36,000 a year in expenses. The opportunity cost of capital is 11%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent Annual Savings= ???

Explanation / Answer

Equivalent Annual Saving is $ 3,012.44

Working:

a. After tax sale of old machine = 28000*(1-0.40) = $       16,800 b. Purchase cost of Glueball $       1,60,000 Less:Sales of old glueball $           16,800 Cost of Initial Investment $       1,43,200 c. Annual Depreciation $       1,43,200 / 10 = $           14,320 d. Anunal Saving $           36,000 Less:Annual Depreciation $           14,320 Income befor tax $           21,680 Incom Tax expense $             8,672 Net Income $           13,008 Add:Depreciation Expense $           14,320 Annual Cash flow $           27,328 e. Present value of annuity of 1 = (1-(1+i)^-n)/i Where, = (1-(1+0.11)^-10)/0.11 i 11% =               5.8892 n 10 f. Present Value of annual cash flows $           27,328 x      5.8892 = $ 1,60,940.93 Less:Costs of Initial investment $ 1,43,200.00 Net Present Value $     17,740.93 g. Net Present Value $     17,740.93 / Present Value of annuity of 1               5.8892 Equivalent Annual Saving $       3,012.44

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