Question

Blazer Video Production is a producer of commercials and corporate information videos. They have a high-tech studio with multiple high-intensity lights. Blazer is considering switching out the lights for more energy efficient LED lights, which do not generate the tremendous amounts of heat that the current lights put out and do not require frequent bulb replacements. The new lights would cost $10,000 and would be depreciated straight-line over their five-year useful life and are expected to have no salvage value. The existing lights were purchased for $8,000 five years ago and were being depreciated straight-line over their ten-year useful life and were not expected to have any salvage value. The old lights had a longer life expectancy because of the frequent bulb replacement. The existing lights could currently be sold for $4,000. The lights are not expected to change revenues at all, but will save $2,000 per year in electricity and bulbs. The firm’s tax rate is 25% and the required rate of return is 10%. Calculate the IRR. Should Blazer purchase the replacement lights? Hint: Remember to include the difference in annual depreciation in your cash flows.

Answer 1

IRR

15.24%

The lights should be purchased since IRR is greater than the required return.

Year	Initial cost	Tax shield= Tax rate * (New depreciation - old depreciation)	Salvage	Net revenue after tax	Net cash flow
0	-6000				-6000
1		300		1500	1800
2		300		1500	1800
3		300		1500	1800
4		300		1500	1800
5		300	0	1500	1800

(There is no tax on sale of old lights since they are sold at book value of $4000(8000- 8000*5/10))** Initial cost = Cost of new lights - salvage of old lights after tax