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 $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

Annual depreciation on new glueball = 30,000 / 10 = $ 3000

Tax savings on annual depreciation = 3000 * 40% = 1200

After tax savings = 8000 (1 -.40 )

                                = 8000 *.60

                               = 4800

Total savings = 1200 +4800 = $ 6000

Present value of cash flow = PVAF@10%,10 *Total savings

                                                    = 6.144567 * 6000

                                                     = $ 36867.40

Initial investment = 30000 -5000 = 25000

NPV = Present value -Initial investment

         = 36867.40 - 25000

        = 11867.40

.

Equivalent annual savings = NPV /PVAF@10%,10

                                                  = 11867.4 / 6.144567

                                                  = $ 1931.37

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