Gluon Inc. is considering the purchase of a new high pressure glueball. It can p
ID: 2745140 • Letter: G
Question
Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $40,000 and sell its old low-pressure glueball, which is fully depreciated, for $6,000. The new equipment has a 10-year useful life and will save $10,000 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 $40,000 and sell its old low-pressure glueball, which is fully depreciated, for $6,000. The new equipment has a 10-year useful life and will save $10,000 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.)
Equivalent annual savings $Explanation / Answer
Initial Investment
Cost of new glue ball = 40,000
Salvage value of old glue ball = -6000
Tax on sale of old glue ball (6000 x 40%) = 2,400
Initial Investment = 36,400
Annual depreciation = (cost of asset – salvage value)/ life
= (40,000-0)/10
= 4,000
Annual cash flow = cost saving x (1- tax rate) + annual depreciation x tax rate
= 10,000 x (1-0.40) + 4,000 x 0.40
= 7,600
NPV = annual cash flow x PVIFA (10, 12%) – initial investment
= 7,600 x 5.650223 - 36,400
= 6,541.69
Equivalent annual savings =NPV/ PVIFA (10, 12%)
= 6,541.69 / 5.650223
= 1,157.78
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