Gluon Inc. is considering the purchase of a new high pressure glueball. It can p
ID: 2714899 • Letter: G
Question
Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $30,000 and sell its old low-pressure glueball, which is fully depreciated, for $5,000. The new equipment has a 10-year useful life and will save $8,000 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
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Initial cost (30,000) Sales value old glueball 5,000 Revenue Increase/Expense saving 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 Less Depreciation (3,000) (3,000) (3,000) (3,000) (3,000) (3,000) (3,000) (3,000) (3,000) (3,000) Net incremental Income before tax 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 Tax on saving@40% 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 Post Tax saving 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 Add back depreciation 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 Total Increase in Cash Flow 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 Discount factor @10% 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 PV of cash flows (25,000) 5,455 4,959 4,508 4,098 3,726 3,387 3,079 2,799 2,545 2,313 NPV 11,867 Annuity factor for PV @10% 6.145 PV of cash inflows 36,867.403 Equivalent Annual savings on NPV basis =NPV/Annuity factor= $ 1,931.37 Equivalent Annual savings on Cash Inflow PV basis =Total PV of cash flows/Annuity factor= $ 6,000.00
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