Scorecard Corporation is considering the purchase of new manufacturing equipment

Question

Scorecard Corporation is considering the purchase of new manufacturing equipment that will cost $15,000 (including shipping and installation). Scorecard can take out a four-year, $15,000 loan to pay for the equipment at an interest rate of 3.60%. The loan and purchase agreements will also contain the following provisions: The annual maintenance expense for the equipment is expected to be $150 The equipment has a four-year depreciable life. The Modified Accelerated Cost Recovery System's (MACRS) depreciation rates for a three-year asset are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. · The corporate tax rate for Scorecard is 35%. Note: Scorecard Corporation is allowed to take a full-year depreciation tax-saving deduction in the first year. Based on the preceding information, complete the following tables: Value Annual loan payment will be Annual tax savings from maintenance will be Year 1 Year 2 Year 3 Year 4 Tax savings from depreciation Net cash flow Thus, the net present value (NPV) cost of owning the asset will be: O -$10,348 O $12,520 O -$9,84:7 O -$21,927

Explanation / Answer

(i) Annual loan payment - Loan amount / PVAF(Interest rate, loan period) Loan amount = 15000 PVAF(3.6%,4) = 3.6644 Annual loan payment = 4093.47 Or Use PMT fumction in Excel = =-PMT(3.6%,4,15000) Maintainance cost = 150 Tax rate = 35% Tax savings = 52.5 Since discount rate is not given we assume post tax interest rate on loan as cost of capital. 3.6 x (1- 0.35) = 2.34 (ii) Depreciation tax savings (DTS) and PV of DTS Year Depreciation rates Depreciation Depreciation tax savings (Dep. X tax rate) 1 33.33 4999.5 1749.825 2 44.45 6667.5 2333.625 3 14.81 2221.5 777.525 4 7.41 1111.5 389.025 Year Beginning balance Payments Interest Principle Ending balance Interest tax savings Annual post tax maintainance cost DTS Net cash flow PV factors @ 2.34% NPV 1 15000 4093.47 540.00 3553.47 11446.53 189.00 97.5 1749.825 2252.14 0.977135 2200.646 2 11446.53 4093.47 412.08 3681.39 7765.14 144.23 97.5 2333.625 1713.11 0.954793 1635.67 3 7765.14 4093.47 279.55 3813.92 3951.22 97.84 97.5 777.525 3315.60 0.932962 3093.328 4 3951.22 4093.47 142.24 3951.22 0.00 49.79 97.5 389.025 3752.16 0.911629 3420.576 10350.22 Approx 10348 (a) These cashflows are negative as represents cost i.e. outflows therefore negative sign. Please provide feedback…. Thanks in advance…. :-)

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