Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $160,000 and sell its old low-pressure glueball, which is fully depreciated, for $28,000. The new equipment has a 10-year useful life and will save $36,000 a year in expenses. The opportunity cost of capital is 11%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent Annual Savings= ???

Answer 1

Equivalent Annual Saving is $ 3,012.44

Working:

a.

After tax sale of old machine

=

28000*(1-0.40)

=

$       16,800

b.

Purchase cost of Glueball

$       1,60,000

Less:Sales of old glueball

$           16,800

Cost of Initial Investment

$       1,43,200

c.

Annual Depreciation

$       1,43,200

/

10

=

$           14,320

d.

Anunal Saving

$           36,000

Less:Annual Depreciation

$           14,320

Income befor tax

$           21,680

Incom Tax expense

$             8,672

Net Income

$           13,008

Add:Depreciation Expense

$           14,320

Annual Cash flow

$           27,328

e.

Present value of annuity of 1

=

(1-(1+i)^-n)/i

Where,

=

(1-(1+0.11)^-10)/0.11

i

11%

=

5.8892

n

10

f.

Present Value of annual cash flows

$           27,328

x

5.8892

=

$ 1,60,940.93

Less:Costs of Initial investment

$ 1,43,200.00

Net Present Value

$     17,740.93

g.

Net Present Value

$     17,740.93

/ Present Value of annuity of 1

5.8892

Equivalent Annual Saving

$       3,012.44