e) Three years ago, a company purchased a system of modular office furniture at
ID: 2646203 • Letter: E
Question
e) Three years ago, a company purchased a system of modular office furniture at a cost of $29,000.
Straight-line depreciation with no salvage value and a 5-year recovery period was used to write
off the capital investment. A market value of $12 ,600 is expected if the system is sold now. If the system is kept, the company expects annual maintenance costs of $5500 each year and zero market value at the end of useful life. If the company decides to buy a new system, the new system will cost $32,000 and have a zero market value at the end of the estimated life of 5 years.
The company expects annual maintenance costs of $8 500 each year. Assume an effective taxrate of 39% and an after-tax MARR of 7% per year.
Determine whether the replacement now is economica
Explanation / Answer
Depreciation as per straight line method on old system=$29,000/5=$5,800.
Written down value of the machine = $29,000 - $5,800 * 2 =$17,400.
Current market value of the system = $12,600.
Loss on sale of old system = $17,400 - $12,600 = $5,100
Tax savings from sale of old system = $5,100 * 39% = $1,989
Cost of new system =$32,000
Net Cash outlfow in year 0 =Cost of new system - tax savings on account of sale of old system at loss - Cash inflow as a result of sale of old system
= $32,000 - $12,600 - $1,989.
=$17,411.---------------------(A)
Incremental annual maintenance cost =$8,500 - $5,500 =$3,000
Depreciation on the new system = $32,000/5 = $6,400
Incremental depreciation.=$6,400 - $5,800= $600
Incremental costs = Incremental annual maintenance cost+ Incremental depreciation
=$3,000+ $600 =$3,600
Tax savings on incremtnal costs= $3,600 * 0.39= $1,404
Incremental cash inflows = $1,404 + $600 (Incremental depreciation)
=$2,004.
Present value annuity factor @7% for 5 years =4.100
Present value of incremental cash inflows= 4.100 * $2,004 = $8,216.40 -----------------(B)
NPV = Present value of Cash inflows - Present value of cash outlfows
=$8,216.40 - $17,411
=- $9,194.60
As the NPV is negative the replacment should not be undertaken.
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