Shoe Building Inc. (SBI) is considering the purchase of new manufacturing equipm

ID: 2728588 • Letter: S

Question

Shoe Building Inc. (SBI) is considering the purchase of new manufacturing equipment that will cost $15,000 (including shipping and installation). SBI can take out a four-year, $15,000 loan to pay for the equipment at an interest rate of 3.60%. The loan and purchase agreements will also contain the following provisions: The annual maintenance expense for the equipment is expected to be $150. The equipment has a four-year depreciable life. The Modified Accelerated Cost Recovery System's (MACRS) depreciation rates for a three-year asset are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. The corporate tax rate for SBI is 40%. · Note: Shoe Building Inc. (SBI) is allowed to take a full-year depreciation tax-saving deduction in the first year. Based on the preceding information, complete the following tables: Value Annual loan payment will be: Annual tax savings from maintenance will be: Year 1 Year 2 Year 3 Year 4 Tax savings from depreciation Net cash flow

Explanation / Answer

Calculation of Annual Loan payment:

Loan amount

15000

Loan term (Years )

Interest rate

3.60%

Present Value of annuity $ 1 (4 years , 3.60%)

3.66438

Annual Loan Payment = 15000/3.66438

$ 4,093.47

Calculation of Annual tax saving from maintenance :

Annual maintenance charges

$ 150

Tax Rate

40%

Annual tax saving from maintenance = 150*40% =

$ 60

Calculation of Tax Saving from Depreciation:

Year 1

Year 2

Year 3

Year 4

MACRS Depreciation %

33.33%

44.45%

14.81%

7.41%

Depreciation

$ 4,999.50

$ 6,667.50

$ 2,221.50

$ 1,111.50

= Total cost * Dep. % =

(15000*33.33%)

(15000*44.45%)

(15000*14.81%)

(15000*7.41%)

Tax Saving from Depreciation = Depreciation * Tax Rate (40%)

$ 1,999.80

$ 2,667.00

$ 888.60

$ 444.60

Calculation of Net Cash Flows:

Tax Saving from Depreciation

$ 1,999.80

$ 2,667.00

$ 888.60

$ 444.60

Add: Tax saving from maintenance

$ 60.00

Less: Annual Loan payment

$ (4,093.47)

Less: Annual Maintenance cost

$ (150.00)

Net Cash Flows

$ (2,183.67)

$ (1,516.47)

$ (3,294.87)

$ (3,738.87)