Hercules Exercise Equipment Co. purchased a computerized measuring device two ye

Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $94,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $42,800. A new piece of equipment will cost $310,000. It also falls into the five-year category for MACRS depreciation. Assume the new equipment would provide the following stream of added cost savings for the next six years. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. Year savings 1 $69,000 2 59,000 3 57,000 4 55,000 5 52,000 6 41,000 The firm's tax rate is 35 percent and the cost of capital is 10 percent. a. What is the book value of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.) Book value 45 b. What is the tax loss on the sale of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.) Tax loss P$ 2,32 c. What is the tax benefit from the sale? (Do not round intermediate calculations and round your answer to the nearest whole dollar.) Tax benefit 81 d. What is the cash inflow from the sale of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.) Cash inflow 43,61 e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.) Net cost 266,38

Explanation / Answer

Answer to question no. f & g :-

As per MACRS depreciation schedule depreciation rates are :-

Y1 - 20 %

Y2 - 32%

Y3 - 19.20%

Y4 - 11.52%

Y5 - 11.52%

Y6 - 5.76%

Answer to question no. h :-

Tax Shield Benefits = Incremental Depreciation * Tax Rate

Answer to question no j-1 :-

Total Annual Benefits = Tax Shield benefits from Depreciation + Aftertax Cost Savings

Answer to question no j-2 :-

Using cost of capital r = 10%, we calculate present value of total annual benefits as follows :-

$60233/(1+.10)1  + $69287/(1+.10)2  + $54099/(1+.10)3 + $46319/(1+.10)4  + $46278/(1+.10)5  

+ $32943/(1+.10)6

= $231630

Answer to question no k-1 :-

Comparing present value of incremental benefits to the net cost of the new equipment :-

$231630 - $266388 = - $34758

Answer to question no k-2 :-

No

The replacement should not be undertaken as the net cost of the equipment is more than the present value of incremental benefits .

Year Depreciation on new equipment (A) Depreciation on old equipment (B) Incremental Depreciation (A-B) Tax Rate Tax Shield Benefits ($) 1 62000 18048 43952 0.35 15383 2 99200 10810 88390 0.35 30937 3 59520 10810 48710 0.35 17049 4 35650 5452 30198 0.35 10569 5 35650 35650 0.35 12478 6 17980 17980 0.35 6293

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