The expected annual maintenance expense for a new piece of equipment is $10,000.
ID: 2451751 • Letter: T
Question
The expected annual maintenance expense for a new piece of equipment is $10,000. This is Alternative A. Alternatively, it is possible to perform the maintenance every fifth year at a cost of $50,000 (Alternative B). In either case, maintenance will be performed in the fifth year so that the equipment can be sold for $100,000 at that time. If the MARR is 15% per year (before income taxes), which alternative should be recommended in each of these situations? Before income taxes are considered. After income taxes are considered when t = 40%. Is there a different selection before and after income taxes are considered?Explanation / Answer
a)Before taxes considered
PV of cash out flows as per proposal A=$10,000*AFPV for 5 years@15%-$1,00,000*Pv of 5th year
=$10,000*3.3522-$1,00,000*0.4972=-$16,198
PV of cash out flows as per proposal B=$10,000*AFPV for 5 years@15%-$50,000*Pv of 5th year=-$24,860
Proposal B is acceptable
b)
PV of cash out flows as per proposal A=$10,000*AFPV for 5 years@15%*(1-Tax rate)-$1,00,000*Pv of 5th year*(1-Tax rate)
=$10,000*3.3522*.6-$1,00,000*0.4972*.6=-$9,718
PV of cash out flows as per proposal B=$10,000*AFPV for 5 years@15%*.6-$50,000*Pv of 5th year**.6
=-$14,916
Proposal b is acceptble
c) There is no change in decision if tax considered or not in this case
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