Question

Happy Chappy Ltd are investigating the replacement of an existing piece of equipment with a more sophisticated one.

The old equipment cost $100,000 two years ago. It has been depreciated at a straight-line rate of 20%. If sold today, the old equipment would sell for $50,000. It has three years of usable life remaining, but at the end of its life would have zero salvage value.

The new equipment would cost $150,000 plus $20,000 installation costs. It would be depreciated straight-line at 20% through-out its three year useful life. At the end of its life, it could be sold for $80,000.

As a consequence of purchasing the new equipment, operating costs (excluding depreciation) would decrease by $30,000 in each of the next three years. The firm pays tax on income of 33 per cent, and the relevant discount rate for the project is 16 per cent.

The incremental annual depreciation to be claimed as a result of the purchase of new equipment is:

What is the NPV:

The book values for the old and new equipment at the end of year three (i.e. three years from now) are, respectively:

The sale of the new equipment at the end of year three results in:

Please show ALL working out, so I can understand what to do

Answer 1

Calculation of Incremental Depreciation
Cost (150000+20000)	170000
Less: Salvage value	80000
Depreciable Value	90000
Useful Life	3 Years
Depreciation Annually 20%	18000
Caculation of NPV	Year 0	Year 1	Year 2	Year 3
Initial Cost	-170000
Sale Proceeds of Old equipment	50000
Tax Saving on Loss on sale of old equipment	3300
Tax Saving on Dep. On New Equipment		5940	5940	5940
Saving in Operating Costs annualy		30,000	30,000	30,000
Sale Proceeds of New equipment				80000
Tax saving on loss on sale of new equipment				11880
Net Cash Flows	-116700	35940	35940	127820
PVF @ 16%	1	0.862	0.743	0.641
Present Value	-116700	30980	26703	81933
NPV	22916
Calculation of Book Values at Year 3 End	Old Machine			New Machine
	Year 1	Year 2	Year 3	Year 1	Year 2	Year 3
Opening	60000	40000	20000	170000	152000	134000
Less: Dep	20000	20000	20000	18000	18000	18000
Closing	40000	20000	0	152000	134000	116000
The Sale of New Equipment at Year 3 End
would result in :
Book Value	116000
Sale Proceeds	80000
Profit (Loss)	36000
Working Note:
Calculation of Book value at Year 0 for old equipment
Cost 2 year back	100000
Dep for 2 years	40000
Book value now	60000
Sale proceeds	50000
Loss	10000
Tax Saving on Loss	3300