Help. A commercial environmental laboratory is considering the purchase of a new

Question

Help.

A commercial environmental laboratory is considering the purchase of a new component part for an analytical instrument that will improve its performance. The part costs $20,000. The upgrade means that more environmental samples can be analyzed per instrument, resulting in an estimated 54,000 benefit the first year after purchase, increasing $1,000 each year thereafter until the instrument is retired in seven years. With minor improvements, the lab can sell the instrument for $5,000. Because the lab owns several hundred of these instruments, it wants to determine the economic attractiveness of committing to the purchase with inflation and tax incorporated into the determination. The accountant for the lab allows for an 18% MARR. For taxation purposes, the laboratory's annual income is eight million dollars. The accountant suggests basing the economy's inflation rate to the years 2001-2008. The IRS requires this business to use MACRS for its depreciation schedule and considers the component part to be R & D equipment. a) Determine the constant-dollars after tax cash flow. b) Draw the constant-dollars after tax cash flow diagram. c) What are the total taxes paid? (NOTE: Specify if nominal or constant dollars) d) Perform an engineering economic analysis to determine if the purchase of the component part is economically attractive after inflation and taxes (constant-dollars). e) What is the decision? f) What salvage value would be acceptable? (Perform a simple sensitivity analysis to determine this value.)

Explanation / Answer

First we have certain assumptions for calculations. We assume for depreciation purpose the asset was placed in service at the start of the first year. And we assume the inflation rate to be 2% and the tax rate to be 35%.

The depreciation will be calculated as

Ans a

Year Book value Depreciation rate Depreciation 1 20000 25% 5000 2 15000 21.43% 3214.5 3 11785.5 15.31% 1804.36 4 9981.14 10.93% 1090.94 5 8890.20 8.75% 777.89 6 8112.31 8.74% 709.02 7 7403.29 8.75% 647.79 6755.50

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