First American Incorporated is considering buying a new copier. It will cost $9,

Question

First American Incorporated is considering buying a new copier. It will cost $9,000 to purchase and $1,000 to ship and install. It has a five year class life. At the end of four years they plan to sell the copier for $3,500. The new copier will allow FA to increase revenues by $2,000 each year but expenses will also increase by $500 each year. Account receivables will increase by $500 and account payables will increase by $800 if the copier is purchased.Straight-line depreciation will be used. FA’s marginal tax rate is 34% and its cost of capital is 5%. Should FA purchase the new copier?

Explanation / Answer

Since the company is incurring a loss, hence it is not advisable for it to purchase the new copier.

Cost of the copier 10000 (9000+1000) Life 5 years SV at end of 4 years 3500 Particulars                         1                                  2                   3                4 Incremental revenue             2,000.00                      2,000.00       2,000.00    2,000.00 Less: incremental costs                500.00                         500.00          500.00       500.00 Net revenue             1,500.00                      1,500.00       1,500.00    1,500.00 Les: depreciation             1,625.00                      1,625.00       1,625.00    1,625.00 Earnings before taxes               -125.00                       -125.00        -125.00      -125.00 Less: depreciation @34%                 -42.50                         -42.50          -42.50        -42.50 Earnings after taxes                 -82.50                         -82.50           -82.50        -82.50

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