The Lancaster Corporation purchased a piece of equipment three years ago for $25

Question

The Lancaster Corporation purchased a piece of equipment three years ago for $250,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $97,920.

A new piece of equipment can be purchased for $360,000. It also has an ADR of eight years.

The firm has a 36% tax rate and a 9% cost of capital.

Assume the old and new equipment would provide the following operating gains (or losses) over the next six years:

Year New Equipment Old Equipment
1 $100,000 $36,000
2 86,000 26,000
3 80,000 19,000
4 72,000 18,000
5 62,000 16,000
6 43,000 (9,000)

What is the old equipment value at T0, the amount kept after the sale of the old equipment at T0, net outflow at T0, new equipment book value at T6, net cash flow amounts at T1, T2, T3, T4, T5 and T6, and NPV?

Explanation / Answer

Replacement Decision Analysis Lancaster Corporation Book Value of Old Equipment (ADR of 8 years indicates the use of the 5-year MACRS schedule) Year Depreciation Base Percentage Depreciation (Table 12-9) Annual Depreciation 1 $250,000 .200 $ 50,000 2 250,000 .320 80,000 3 250,000 .192 48,000 Total depreciation to date $178,000 Purchase price $250,000 – Total depreciation to date 178,000 Book value $ 72,000 CP 12-1. (Continued) Tax Obligation on the Sale Sales price $97,920 Book value 72,000 Taxable gain 25,920 Tax rate 36% Taxes $ 9,331 Cash Inflow From the Sale of the Old Equipment Sales price $97,920 Taxes 9,331 $88,589 Net Cost of the New Equipment Purchase price $360,000 – Cash inflow from the sale of the old equipment 88,589 Net cost of new equipment $271,411 Depreciation Schedule of the New Equipment. (ADR of 8 years indicates the use of 5-year MACRS Schedule) Year Depreciation Base Percentage Depreciation (Table 12-9) Annual Depreciation 1 $360,000 .200 $ 72,000 2 360,000 .320 115,200 3 360,000 .192 69,120 4 360,000 .115 41,400 5 360,000 .115 41,400 6 360,000 .058 20,880 $360,000 CP 12-1. (Continued) Depreciation Schedule for the Remaining Years of the Old Equipment. Year* Depreciation Base Percentage Depreciation (Table 12-9) Annual Depreciation 1 $250,000 .115 $28,750 2 250,000 .115 28,750 3 250,000 .058 14,500 *The next three years represent the last three years of the old equipment. Incremental Depreciation and Tax Shield Benefits. (1) (2) (3) (4) (5) (6) Year Depreciation on new Equipment Depreciation on old Equipment Incremental Depreciation Tax Rate Tax Shield Benefits 1 $ 72,000 $28,750 $43,250 .36 $15,570 2 115,200 28,750 86,450 .36 31,122 3 69,120 14,500 54,620 .36 19,663 4 41,400 41,400 .36 14,904 5 41,400 41,400 .36 14,904 6 20,880 20,880 .36 7,517 Aftertax cost savings New Equipment Old Equipment Cost Savings (1 – Tax Rate) Aftertax Savings $100,000 $36,000 $64,000 .64 $40,960 86,000 26,000 60,000 .64 38,400 80,000 19,000 61,000 .64 39,040 72,000 18,000 54,000 .64 34,560 62,000 16,000 46,000 .64 29,440 43,000 (9,000) 52,000 .64 33,280 CP 12-1. (Continued) Present value of the total incremental benefits. (1) (2) (3) (4) (5) (6) Year Tax Shield Benefits from Depreciation After Tax Cost Savings Total Annual Benefits Present Value Factor 9% Present Value 1 $15,570 $40,960 $56,530 .917 $ 51,838 2 31,122 38,400 69,522 .842 58,538 3 19,663 39,040 58,703 .772 45,319 4 14,904 34,560 49,464 .708 35,021 5 14,904 29,440 44,344 .650 28,824 6 7,517 33,280 40,797 .596 24,315 Present value of incremental Benefits $243,855 Net Present Value Present value of incremental benefits $243,855 Net cost of new equipment 271,411 Net present value ($ 27,556) Based on the net present value analysis, the equipment should not be replaced.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.