Gluon Inc. is considering the purchase of a new high pressure glueball. It can p

Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $220,000 and sell its old low-pressure glueball, which is fully depreciated, for $40,000. The new equipment has a 10-year useful life and will save $48,000 a year in expenses. The opportunity cost of capital is 10%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $220,000 and sell its old low-pressure glueball, which is fully depreciated, for $40,000. The new equipment has a 10-year useful life and will save $48,000 a year in expenses. The opportunity cost of capital is 10%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

The current purchase price is 220000

The annual depriciation is 220000/10 = 22000

Annual saving in Expenses = 48000

- Tax @ 40% = (19200)

Total net saving = 28800

+ Deprciation = 22000

Total saving = 50800 ( since depriciation is a non cash cash, it is added back)

This saving is an annuity and inflow for the firm for next 10 years

So, PV of inflow = 50800 PVIFA (10%, 10)

                            =312144

Total outflow today = cost of machine - net of tax proceeds for old machine

                                = 220000 - (40000 -40% of 40000)

                                 =196000

So, net present value = 312144 - 196000

                                  = 116144

Since, NPV is positive , we can accept the project.

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