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

Question

Gluon Inc. is considering the purchase of a new high pressure glueball.It can purchase the glueball for $190,000 and sell its old low-pressure glueball, which is fully depreciated, for $34,000. The new equipment has a 10-year useful life and will save $42,000 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.) Equivalent annual savings

Explanation / Answer

Step 1 – Operating Cash flow calculation

Operating Cash flow = [(Revenues – Savings in cash expenses) x (1-Tax Rate)] + [Depreciation x (1-Tax Rate)]

= [($0 - $42,00) x (1-0.40)] + [ ($190,000/10 Years) x 0.40]

= $32,800

Step 2 – Calculation of Net Present Value

Net Present Value = [Cash flow x (PVIFA 11%, 10 Years] + [Sales Price x (1-tax Rate)] – Purchase Cost

= [$32,800 x 5.889232] + [$34,000 x 0.60] - $190,000

= $1,93,166.81 + 20,400 – 190,000

= $23,566.81

Step 3 – Equivalent Annual Savings

Equivalent Annual Savings = Net Present Value / (PVIFA 11%, 10 Years)

= $23,566.81 / 5.889232

= $4,001.68

“Therefore, The Equivalent Annual Savings = $4,001.68”

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