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 $78,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $34,800. A new piece of equipment will cost $230,000. 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.

The firm’s tax rate is 40 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.)
  

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.)
  

c. What is the tax benefit from the sale? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)
  

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.)
  

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.)
  

f. Determine the depreciation schedule for the new equipment. (Round the depreciation base and annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)
  

g. Determine the depreciation schedule for the remaining years of the old equipment. (Round the depreciation base and annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)
  

h. Determine the incremental depreciation between the old and new equipment and the related tax shield benefits. (Enter the tax rate as a decimal rounded to 2 decimal places. Round all other answers to the nearest whole dollar.)
  

i. Compute the aftertax benefits of the cost savings. (Enter the aftertax factor as a decimal rounded to 2 decimal places. Round all other answers to the nearest whole dollar.)
  

j-1. Add the depreciation tax shield benefits and the aftertax cost savings to determine the total annual benefits. (Do not round intermediate calculations and round your answers to the nearest whole dollar.)
  

j-2. Compute the present value of the total annual benefits. (Do not round intermediate calculations and round your answer to the nearest whole dollar.)
  

k-1. Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e). (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to the nearest whole dollar.)
  

k-2. Should the replacement be undertaken?
  

Year Cash Savings 1 $ 61,000 2 51,000 3 49,000 4 47,000 5 44,000 6 33,000 Appendix B Present value of $1,PVF PV=FV Percent Period 4 Appendlx B (concluded) Percent Period 50% 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 0.640 0.592 0.549 0.510 0.444 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 0512 0.455 0.406 0.364 0.296 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 0.262 0.207 0.165 0.133 0.088 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 0.210 0.159 0.122 0.095 0.059 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 0.086 0.056 0.037 0.025 0.012 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065 0.035 0.020 0.011 0.006 0.002 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045 0.023 0.012 0.006 0.003 0.001 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031 0.014 0.007 0.003 0.002 0 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026 0.012 0.005 0.002 0.001 0 0.047 0.038 0.030 0.024 0.020 0.016 0.013 0.010 0.004 0.001 0.001 0 0.026 0.020 0.015 0.012 0.009 0.007 0.005 0.004 0.001 0

Explanation / Answer

1-

book value of old machine

cost of old machine - (cost of machine*rate of acculated depreciation)

78000-(78000*(20%+32%))

37440

2-

loss on sale of old machine

selling price-book value

34800-37440

-2640

3-

tax benefit from sale

2640*40%

1056

4-

cash inflow from sale of old equipment

34800+1056

35856

5-

cost of new equipment

230000

less cash inflow from sale of old equipment

35856

net cost of new equipment

194144

6-

year

cost of new equipment

macrs rate

annual depreciation

1

230000

20%

46000

2

230000

32%

73600

3

230000

19.20%

44160

4

230000

11.52%

26496

5

230000

11.52%

26496

6

230000

5.76%

13248

7-

year

cost of new equipment

macrs rate

annual depreciation

3

78000

19.20%

14976

4

78000

11.52%

8985.6

5

78000

11.52%

8985.6

6

78000

5.76%

4492.8

8-

year

annual depreciation

annual depreciation

incremental depreciation

1

46000

14976

31024

2

73600

8985.6

64614.4

3

44160

8985.6

35174.4

4

26496

4492.8

22003.2

5

26496

26496

6

13248

13248

9-

year

0

1

2

3

4

5

6

cash outflow

-194144

cash savings

61000

51000

49000

47000

44000

33000

less incremental depreciation

31024

64614.4

35174.4

22003.2

26496

13248

before tax savings

29976

-13614.4

13825.6

24996.8

17504

19752

less depreciation-40%

11990.4

-5445.76

5530.24

9998.72

7001.6

7900.8

after tax savings

17985.6

-8168.64

8295.36

14998.08

10502.4

11851.2

add incremental depreciation

31024

64614.4

35174.4

22003.2

26496

13248

net operating savings

-194144

49009.6

56445.76

43469.76

37001.28

36998.4

25099.2

present value of cash flow = cash flow/(1+r)^n r = 10%

-194144

44554.18

46649.38843

32659.47

25272.37

22973.1

14167.844

net present value = sum of present value of cash flow

-7867.64

no replacement should not be made as it results in negative npv

1-

book value of old machine

cost of old machine - (cost of machine*rate of acculated depreciation)

78000-(78000*(20%+32%))

37440

2-

loss on sale of old machine

selling price-book value

34800-37440

-2640

3-

tax benefit from sale

2640*40%

1056

4-

cash inflow from sale of old equipment

34800+1056

35856

5-

cost of new equipment

230000

less cash inflow from sale of old equipment

35856

net cost of new equipment

194144

6-

year

cost of new equipment

macrs rate

annual depreciation

1

230000

20%

46000

2

230000

32%

73600

3

230000

19.20%

44160

4

230000

11.52%

26496

5

230000

11.52%

26496

6

230000

5.76%

13248

7-

year

cost of new equipment

macrs rate

annual depreciation

3

78000

19.20%

14976

4

78000

11.52%

8985.6

5

78000

11.52%

8985.6

6

78000

5.76%

4492.8

8-

year

annual depreciation

annual depreciation

incremental depreciation

1

46000

14976

31024

2

73600

8985.6

64614.4

3

44160

8985.6

35174.4

4

26496

4492.8

22003.2

5

26496

26496

6

13248

13248

9-

year

0

1

2

3

4

5

6

cash outflow

-194144

cash savings

61000

51000

49000

47000

44000

33000

less incremental depreciation

31024

64614.4

35174.4

22003.2

26496

13248

before tax savings

29976

-13614.4

13825.6

24996.8

17504

19752

less depreciation-40%

11990.4

-5445.76

5530.24

9998.72

7001.6

7900.8

after tax savings

17985.6

-8168.64

8295.36

14998.08

10502.4

11851.2

add incremental depreciation

31024

64614.4

35174.4

22003.2

26496

13248

net operating savings

-194144

49009.6

56445.76

43469.76

37001.28

36998.4

25099.2

present value of cash flow = cash flow/(1+r)^n r = 10%

-194144

44554.18

46649.38843

32659.47

25272.37

22973.1

14167.844

net present value = sum of present value of cash flow

-7867.64

no replacement should not be made as it results in negative npv

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