You are considering adding a new software title to those published by your highl

Question

You are considering adding a new software title to those published by your highly successful software company. If you add the new product, it will use capacity on your disk duplicating machines that you had planned on using for your flagship product, “Battlin’ Bobby.” You had planned on using the unused capacity to start selling “BB” on the west coast in two years. You would eventually have had to purchase additional duplicating machines 10 years from today, but using the capacity for your new product will require moving this purchase up to 2 years from today. If the new machines will cost $111,000 and will be depreciated straight-line over a 5-year period to a zero salvage value, your marginal tax rate is 32 percent, and your cost of capital is 16 percent, what is the opportunity cost associated with using the unused capacity for the new product? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

Annual Depreciation for 5 years = 111,000/5

=$22,200 per year for 5 years

..

Depreciation Tax shield = 22,200*32%

= $7,104

.

Present value of Depreciation Tax Shiled at the time of Purchase = 7104*PVIFA(16%,5)

= 7104*3.2743

= $23,261

Net Purchase Cost = 111,000 - 23,261

= 87.739

Oppurtunity Cost associated with using the unused capacity for the new product = 87739*PVIF(16%,12) - 87739*PVIF(16%,10)

= 87739*0.1685 - 87739*0.2267

= -$5106.41 ....Ans

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