Rozetta Manufacturing Company (RMC) is considering the purchase of a new equipme
ID: 2776815 • Letter: R
Question
Rozetta Manufacturing Company (RMC) is considering the purchase of a new equipment to replace the old one. The old equipment was purchased 5 years ago at a cost of $20,000, and it is being depreciated on a straight-line basis to a zero salvage value over a 10-year life. The current market value of the old equipment is $14,000. The new equipment, which falls into the MACRS 5-year class, has an estimated life of 5 years; it costs $28,000 with installation and adjustment charges of $2,000. RMC plans to sell the equipment at the end of the fifth year for $1,000. The applicable depreciation rates are 0.20, 0.32, 0.19, 0.12, 0.11, and 0.06. The new equipment is expected to reduce operating expenses by $3,000 per year, while sales are not expected to change (that is the new equipment is expected to generate before-tax cash savings of $3,000 per year). RMC’s tax rate is 40% and its WACC is 10%.
Explanation / Answer
Cost of new equipment c 28,000.00 BV of old equipment b 8,000.00 Salvage value of old equipment s 14,000.00 Tax t 0.4 Total Cash outflow c-s+t*(s-b) 98002800 X New Equipment Value 28000 Depreciation d 6,000.00 Before tax saving 3,000.00 Cash Saving Per year Before tax saving *(1-t)+td WACC 0.10 Depriciation according to MACRS 1 2 3 4 5 20% 32% 19% 12% 11% 6% Depriciation according to MACRS 6000 9600 5700 3600 3300 1800 Years 1 2 3 4 5 Cash flows 4,200.00 5,640.00 4,080.00 3,240.00 3,120.00 2,520.00 PV of cash flows 3,783.78 4,577.55 2,983.26 2,134.29 1,851.57 Sum of PV of cash flow 15,330.45 Cash from sale of equipment S-t*(S-B) 600.00 Salvage value of new equipment S 1,000.00 BV of New equipment B - Total Cash Inflow 15,930.45 Y NPV Y-X NPV (1,669.55) Since NPV is -ve firm should not replace equipment
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