Gluon Inc. is considering the purchase of a new high pressure glueball. It can p

Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $60,000 and sell its old low-pressure glueball, which is fully depreciated, for $10,000. The new equipment has a 10-year useful life and will save $14,000 a year in expenses. The opportunity cost of capital is 11%, 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.)

Explanation / Answer

Calculation of the equivalent annual savings from the purchase of new high pressure glueball Year 0 1-10 Net Present Value Cost of Purchase -$60,000.00 Sale of old glueball [$1000 * (1-tax rate i.e.0.40)] $6,000.00 Total savings $140,000.00 Tax @ 40 % on total savings [$140000 * 40%] -$56,000.00 Tax savings @ 40% on depreciation [$60000 * 40%] $24,000.00 Net Cash flow -$54,000.00 $108,000.00 x Discount factor @ 11% 1 5.889232 Present value -$54,000.00 $636,037.06 $582,037.06 Equivalent annual savings = Net Present value / Life of new glueball in years Equivalent annual savings = $5,82,037.06 / 10 years = $58,203.71 Working Depreciation per year on new high pressure glueball using straight line method = [Cost - salvage value]/useful life Depreciation per year on new high pressure glueball using straight line method = [$60000 - $0]/10 year = $6000 Annuity factor at 11% for 10 year = [1 - (1+r)^-n]/r r = opportunity cost of capital = 11% n = no.of year = 10 Annuity factor at 11% for 10 year = [1 - (1+0.11)^-10]/0.11 = 5.889232

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