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 $100,000 and sell its old low-pressure glueball, which is fully depreciated, for $18,000. The new equipment has a 10-year useful life and will save $22,000 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.)

Equivalent annual savings $

Explanation / Answer

The Eqquivalent Annual Savings = $ 2684

The calculations are given below:

Years 0 1 to 10 Cash flow for Investment -82000 (100000-18000) Capital Gains Tax on SV of 18000 -7200 (Tax rate assumed to be 40%) (18000 is gain as book value = 0) Net Cash Out flow -89200 Yearly Cost Savings Savings in Cost 22000 Savings in cost after tax shield (22000*0.60) 13200 Add: Tax shield on depreciaton (10000*.4) 4000                     Yearly Cost Savings 17200 PV of Outflows -89200 PV of Savings @ 10% (17200*6.145) 105694 NPV 16494 Equivalent Annual Savings (16494/6.145) 2684 $ Note: If the capital gains tax is different from 40% cash outflows at time = 0, to be revised.

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