2. A highly specialized piece of equipment has a first cost of $50,000. If this

Question

2. A highly specialized piece of equipment has a first cost of $50,000. If this equipment is purchased, it will be used to produce income (through rental) of $20,000 per year for only four years. Estimated annual expenses for upkeep are $3,000 per year during each of the four years. The MACRS (GDs) recovery period for the equipment is seven years and the effective income tax rate is 40%. The firm's after-tax MARR is 796 per year. a. Assume that the equipment is placed on standby status after four years of service such that the depreciation is taken over the full MACRS recovery period. Since the equipment is on standby status the BTCF will be zero after the fourth year of use. However, a DWO can still be taken on the equipment until it is fully depreciated. Use a PW analysis and determine if the equipment should be purchased. b. Assume that the equipment will be donated to a university after its fourth year of use. The depreciation deduction in year four will be reduced by 50% due to the half-year convention. The remaining book value will be considered as a negative taxable income in year four thus providing additional tax relief in year four. The Instructor suggests that you separate the computations for these two items in your tabulation. Use a PW analysis and determine if the equipment should be purchased.

Explanation / Answer

a 1/(1+.07)^n Year Initial Outflow Rent Annual Exp Depn Net Income Tax Net Inflow Dis. Rate PV A B C D E=B-C-D F=E*40% G=B-A-C-F H I=G*H 0                     (50,000)    (50,000) 1    (50,000) 1      20,000         (3,000)         (7,145)         9,855         3,942      13,058 0.934579      12,204 2      20,000         (3,000)       (12,245)         4,755         1,902      15,098 0.873439      13,187 3      20,000         (3,000)         (8,745)         8,255         3,302      13,698 0.816298      11,182 4      20,000         (3,000)         (6,245)      10,755         4,302      12,698 0.762895         9,687 5         (4,465)      (4,465)      (1,786)         1,786 0.712986         1,273 6         (4,460)      (4,460)      (1,784)         1,784 0.666342         1,189 7         (4,465)      (4,465)      (1,786)         1,786 0.62275         1,112 8         (2,230)      (2,230)          (892)            892 0.582009            519 NPV            353 b 1/(1+.07)^n Year Initial Outflow Rent Annual Exp Depn Net Income Tax Net Inflow Dis. Rate PV A B C D E=B-C-D F=E*40% G=B-A-C-F H I=G*H 0                     (50,000)    (50,000) 1    (50,000) 1      20,000         (3,000)         (7,145)         9,855         3,942      13,058 0.934579      12,204 2      20,000         (3,000)       (12,245)         4,755         1,902      15,098 0.873439      13,187 3      20,000         (3,000)         (8,745)         8,255         3,302      13,698 0.816298      11,182 4      20,000         (3,000)         (3,123)      13,878         5,551      11,449 0.762895         8,734 4    (18,742)      (7,497)         7,497 0.762895         5,719 NPV         1,026 Half –year convention applies with disposal in year four Conclusion Since in both the situation NPV is positve so equipment should be purchased Year 7-year 1 14.29% 2 24.49% 3 17.49% 4 12.49% 5 8.93% 6 8.92% 7 8.93% 8 4.46% 100.00%

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