Padre Pio owns a small busines and has taxable income of $150,000. He is conside
ID: 2798182 • Letter: P
Question
Padre Pio owns a small busines and has taxable income of $150,000. He is considering four mutually exclusive alternative models of machinery. Which machine should be selected on an after-tax basis? The after-tax MARR is 15%. Assume that each machine is MACRS 5-year property and can be sold for a market value that is 25% of the purchase cost, and the project life is 10 years.
I’m assuming the taxable income of $150,000 implies a tax rate of 39%.
The textbook answer is "C has lowest PW cost at $6801"
Please help because I have no idea how to get this answer.
Thanks
Model I II III IV First Cost $9000 $8000 $7500 $6200 Annual Costs 25 200 300 600Explanation / Answer
The question asked is "Which machine should be selected on an after-tax basis?"
so our answer should be the machine which gives the highest income OR the machine which incurs the lowest cost.
In the given question, the income generated is $150,000 irrespective of the machines used. Hence the appropriate machine would be the one which incurs the lowest cost.
It is calculated as follows:
as seen in the above table, machine IV incurs the lowest cost ($7828.35). Hence the answer is machine IV.
**note 1: MARR is 15% & property life is for 5 years. hence annual cost is calculated by present value annuity factor method (3.352).[1/(1.15)5]
**note 2: Residual value is 25% of first cost(eg.:$9000*25%=2250). since the life of the project is 10 years, itis assumed that Padre Pio will sell machine after 10years hence residual values of machines are been converted to present value of 10th year. [1/(1.15)10].
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