5) (40 points) A is considering purchasing new equipment that is expected to gen

Question

5) (40 points) A is considering purchasing new equipment that is expected to generate an additional company income of S50,000 annually. The equipment will have an initial cost of $75,000 and estimated annual operating and maintenance costs of $30,000. Its estimated salvage value at the end of its useful life of 4 years will be $15,000. The equipment is a MACRS-GDS 3-year property for calculating depreciation deductions. The effective tax rate is 40%. Use an after-tax MARR of 10% per year compounded annually. a) (30 points) For this investment, determine the after-tax cash flow for each year of operation. EOY BTCE MACRS-GDS xable Tax ATCE Deduction. income- b) (10 points) Based on the present worth measure, determine if the company should consider the purchase o this new equipment further?

Explanation / Answer

(a)

Working notes:

(i) MACRS-GDS ignores salvage value. MACRS depreciation schedule is as follows.

(ii) BTCF, years 1-3 ($) = Annual income - Annual O&M costs = 50,000 - 30,000 = 20,000

[BCTF, year 4 ($) = 20,000 + 15,000 (Salvage value) = 35,000]

(iii) Taxable income (TI) = BTCF - Depreciation

(iv) Tax = TI x 40%

(v) ATCF = TI - Tax + Depreciation

[ATCF, year 0 = -$75,000 (Asset cost)]

(b) PW of ATCF is computed as follows. Note that PV Factor in year N = 1 / (1.1)N

Since PW of ATCF is negative, company should not purchase this equipment.

Year Depreciation Base ($) Depreciation Rate (%) Annual Depreciation ($) (A) (B) (C) = (A) x (B) 1 75,000 33.33 24,997.5 2 75,000 44.45 33,337.5 3 75,000 14.81 11,107.5 4 75,000 7.41 5,557.5

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