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 $120,000 and sell its old low-pressure glueball, which is fully depreciated, for $20,000. The new equipment has a 10-year useful life and will save $28,000 a year in expenses. The opportunity cost of capital is 12%, 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.)

    

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $120,000 and sell its old low-pressure glueball, which is fully depreciated, for $20,000. The new equipment has a 10-year useful life and will save $28,000 a year in expenses. The opportunity cost of capital is 12%, 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.)

Explanation / Answer

Step1: Computation of Net present value of after tax cash outflow for 10 years.We have,

Step2: Computation of annual savings.We have,

Annual savings = 28,000 - ( 28,000 x 40%) + 4,800

Annual Savings = 28,000 - 11,200 +4,800 = $ 21,600

Present value savings for expenses and depreciation for 10 years = 21,600 x 5.650 = $ 122,040

Total savings = 122,040 + 20,000 = $ 142,040

Step3: Computation of equivalent annual savings.We have,

Equivalent annual savings = Total saving / PVIFA(12%, 10 years)

  Equivalent annual savings = 142,040 / 5.650 = $ 25,140

Hence,Equivalent annual savings is $ 25,140

Particulars Amount in $ Purchase cost of new machine 120,000 Less: Sale proceeds of old machine ( 20,000) 100,000 Tax Benifits: On Depreciation (120,000 / 10) x 40% (4,800) On Expenses ( 28,000 x 40 %) 11,200 Net of tax benifits 6,400 Net cash outflow for 10 years 6,400 x PVIFA(12%,10 years) 6,400 x 5.650 36,160 Total Net Present Value of after tax cash outflows for 10 years 136,160

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