Question

1.             Hsieh-Hseih Inc. must choosebetween two copiers: The ZZ20or the GG50. (The copier chosen will continue to be selected for the foreseeable future.)

The ZZ20costs $3,000(at t=0) and will last for three years.  For tax purposes, it will be depreciated using the straight line method over a 3- year life (at t=1, 2 and 3). The operating expenses for this copier are $2,200 per year(at t=1, 2 and 3).  This copier will require $500 of inventoryat t=0. Inventory will be decreased to $0 at t=3.

The GG50costs $3,800(at t=0) and will last for four years (t=1, 2, 3, and 4).  For tax purposes, it will (also) be depreciated using the straight line method over a 3- year life (t=1, 2 and 3). The operating expenses for this copier are $1,800 per year(for four years). This copier will require $500 of inventoryat t=0.  Inventory will be decreased to $0 at t=4.

If the appropriate discount rate is 12% and the tax rate is 40%, which copier should be selected?  Why? Be sure to quantify your answer.

Answer 1

Statement showing Annual equivalent cost of ZZ20

Particulars	0	1	2	3	Total
Cost of ZZ20	-3000
WC required	-500
Operating expense		-2200	-2200	-2200
Depreciation		-1000	-1000	-1000
PBT		-3200	-3200	-3200
Tax savings @ 40%		1280	1280	1280
PAT		-1920	-1920	-1920
Add: depreciation		1000	1000	1000
Annual cashflow		-920	-920	-920
Release of WC				500
Total cash flow	-3500	-920	-920	-420
PVIF @ 12%	1.0000	0.8929	0.7972	0.7118
Present value	-3500	-821	-733	-299	-5354
Divided by PVIFA(12%,3 year)					2.40
Annual Equivalent cost					-2229.05

Statement showing Annual equivalent cost of GG50

Particulars	0	1	2	3	4	Total
Cost of ZZ20	-3800
WC required	-500
Operating expense		-1800	-1800	-1800	-1800
Depreciation		-1267	-1267	-1267	0.000
PBT		-3067	-3067	-3067	-1800
Tax savings @ 40%		1227	1227	1227	720
PAT		-1840	-1840	-1840	-1080
Add: depreciation		1267	1267	1267	0
Annual cashflow		-573	-573	-573	-1080
Release of WC					500
Total cash flow	-4300	-573	-573	-573	-580
PVIF @ 12%	1.0000	0.8929	0.7972	0.7118	0.6355
Present value	-4300	-512	-457	-408	-369	-6046
Divided by PVIFA(12%,3 year)						3.04
Annual Equivalent cost						-1990.44

Since Annual equivalent cost of GG50 is less than ZZ20, one should select GG50