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 $110,000 and sell its old low-pressure glueball, which is fully depreciated, for $20,000. The new equipment has a 10-year useful life and will save $24,000 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.

Explanation / Answer

year Cashflow Discount factor@10% Discounted cash Comment 0 -110,000 1 -110000 Capital exp 0 12,000 1 12000 Proceed from old ,achine after tax@40% 1 18,800 0.909090909 17090.90909 Please see working below 2 18,800 0.826446281 15537.19008 3 18,800 0.751314801 14124.71826 4 18,800 0.683013455 12840.65296 5 18,800 0.620921323 11673.32087 6 18,800 0.56447393 10612.10989 7 18,800 0.513158118 9647.372623 8 18,800 0.46650738 8770.338748 9 18,800 0.424097618 7973.035225 10 18,800 0.385543289 7248.213841 NPV 17517.86159 Equalant annual saving 1751.786159 Note Saving of expenses after tax = 24000*(1-0.4) = 14400 Tax saving on depreiation = 110000*10%*40% =4400 Total yearly cashflow = 14400+4400 = 18800

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