A proposed cost-saving device has an installed cost of $630,000. The device will
ID: 2778870 • Letter: A
Question
A proposed cost-saving device has an installed cost of $630,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $45,000, the marginal tax rate is 34 percent, and the project discount rate is 10 percent. The device has an estimated year 5 salvage value of $70,000. What level of pretax cost savings do we require for this project to be profitable? Refer to Table 10.7. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Pretax Cost Savings ___________ ?
Explanation / Answer
Pre-tax annual cost savings = $ 55,856.30
Working
Installed Cost = $630,000
Required initial working capital = $ 45000
Life of the project = 5 years
Discount rate = 10% or 0.10
Marginal Tax rate = 34% or 0.34
Depreciation – Three year MACRS
1st Year = 630000 * 33.33% = $209279
2nd year =630000 * 44.45% = $280035
3rd year = 630000 *14.81% = $93303
Salvage value in 5th year = $ 70000
Let A be the after tax annual cost savings with which the net present value of the project equals zero.
-$630,000 -$45,000 + $209279/1.10 + $280035/1.10^2 + $93303/1.10^3 + $70000/1.10^5 + A*[(1-(1/1.10)^5))/0.10] = 0
-$630,000 -$45,000 + $209279/1.10 + $280035/1.21 + $93303/1.331 + $70000/1.61051 + A*[(1-(1/1.61051))/0.10] = 0
-$675,000 +$190,253.636 + $231,433.884+$70,099.925+$43,464.493 + A * [(1-0.620921)/0.10)] =0
-$139,748.062 + A (0.379079/0.10) = 0
A * 3.79079 = $139748.062
A = $139748.062/3.79079 = $36865.155
After Tax Cost savings = $ 36,865.155
Pre-tax cost savings = $ 36,865.155/(1-0.34)
= $ 36,865.155/0.66 = $55,856.295 or $55,856.30 (rounded off)
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.