I need help answering the following question: Lancaster Corporation (replacement

Question

I need help answering the following question: Lancaster Corporation (replacement decision analysis) 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. 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 $1000, 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)

Explanation / Answer

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 x .200 = $ 50,000

2 250,000x .320= 80,000

3 250,000 x .192 =48,000

Total depreciation to date= $178,000
Purchase price =$250,000
– Total depreciation to date =178,000
Book value= $ 72,000

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Tax Obligation on the Sale
Sales price= $97,920
Book value= 72,000
Taxable gain= 25,920
Tax rate= 36%
Taxes= $ 9,331

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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

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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


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Depreciation Schedule for the Remaining Years of the Old Equipment.
Year* Depreciation Base Percentage Depreciation (Table 12-9) Annual Depreciation
1 $250,000 x .115= $28,750
2 250,000 x.115= 28,750
3 250,000 x.058= 14,500

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*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
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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.

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