Gluon Inc. is considering th purchase of a new high pressure glueball. It can pu

Question

Gluon Inc. is considering th purchase of a new high pressure glueball. It can purchase the glueball for $170,000 and sell its old low-pressure glueball, which is fully depreciated for $30,000. The new equipment has a 10-year usseful life and will save $38,000 a year in expenses. The opportunity cost of capital is 11%, and the firm's tax rate is 40%. What is the equilavent 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 annuals savings _________________

Explanation / Answer

First calculate the initial investment

Initial Investment = 170000 - 30000 = 140000

Yearly savings are 38000, so after tax savings have to be considered in cash flow calculations

After tax cash flow = 38000 * (1-40%) = 22,800

Depreciation each year = 170000 / 10 = 17000

The company gets a depreciation tax shield on this amount = 17000 * 40% = 6800 each year

Total cash flow each year = 22,800 + 6,800 = 29,600

All cash flows are as follows

NPV can be calculated as follows in excel sheet

NPV =NPV(11%,G3:G12)+G2 = $34,321.27

Here 11% is opportunity cost as given is been taken as discount rate.

Equivalent annual savings can be calculated as follows in excel sheet

Equivalent annual savings = PMT(11%,10,-34321.27,0,0) = 5,827.80

Here 11% is discount rate

10 is the number of years

34,321.27 is the present value

0 is future value

0 is for representing payments are made at end of year

Year Cash flow Tax After tax CF Depreciation Depreciation tax shield Total Cash flow 0         (140,000.00) 40%         (140,000.00) 0 0         (140,000.00) 1              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 2              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 3              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 4              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 5              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 6              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 7              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 8              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 9              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00 10              38,000.00 40%              22,800.00            17,000.00               6,800.00              29,600.00

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