Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $88,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $39,800. A new piece of equipment will cost $280,000. 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.

Year		Cash Savings
1		$	66,000
2			56,000
3			54,000
4			52,000
5			49,000
6			38,000

The firm’s tax rate is 35 percent and the cost of capital is 12 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?

c.  What is the tax benefit from the sale?

d. What is the cash inflow from the sale of the old equipment?

e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)

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.)
year

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)

Answer 1

a. What is the book value of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

Year		Depreciation Base	Percentage Depreciation	Annual Depreciation
1		$88,000.00	0.2	$17,600.00
2		$88,000.00	0.32	$28,160.00
Total Depreciation				$45,760.00

Purchase price	$88,000.00
– Total depreciation to date	$45,760.00
Book value	$42,240.00

b.What is the tax loss on the sale of the old equipment?

Book value	$42,240.00
Sales price	39800
Tax loss on the sale	$2,440.00

c.  What is the tax benefit from the sale?

Tax loss on the sale	$2,440.00
Tax rate	35.00%
Tax benefit	$854.00

d. What is the cash inflow from the sale of the old equipment?

Sales price	39800
Tax benefit	$854.00
Cash inflow from the sale of the old equipment	$40,654.00

e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)

Price of the new equipment	280000
– Cash inflow from the sale of the old equipment	$40,654.00
Net cost of the new equipment	$239,346.00

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.)

Year	Depreciation Base	Percentage Depreciation (Table 12-9)	Annual Depreciation
1	$280,000.00	0.2	$56,000.00
2	$280,000.00	0.32	$89,600.00
3	$280,000.00	0.192	$53,760.00
4	$280,000.00	0.115	$32,200.00
5	$280,000.00	0.115	$32,200.00
6	$280,000.00	0.058	$16,240.00

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.)

Year	Depreciation Base	Percentage Depreciation (Table 12-9)	Annual Depreciation
1	$88,000.00	0.192	$16,896.00
2	$88,000.00	0.115	$10,120.00
3	$88,000.00	0.115	$10,120.00
4	$88,000.00	0.058	$5,104.00

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.)

Year	Depreciation on new Equipment	Depreciation on old Equipment	Incremental Depreciation	Tax Rate	Tax Shield Benefits
1	$56,000.00	$16,896.00	$39,104.00	0.35	13,686
2	$89,600.00	$10,120.00	$79,480.00	0.35	27,818
3	$53,760.00	$10,120.00	$43,640.00	0.35	15,274
4	$32,200.00	$5,104.00	$27,096.00	0.35	9,484
5	$32,200.00		$32,200.00	0.35	11,270
6	$16,240.00		$16,240.00	0.35	5,684

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.)

Year	Savings	(1-Tax Rate)	After tax Savings
1	$66,000.00	0.65	$42,900.00
2	56000	0.65	$36,400.00
3	54000	0.65	$35,100.00
4	52000	0.65	$33,800.00
5	49000	0.65	$31,850.00
6	38000	0.65	$24,700.00

j-1. Add the depreciation tax shield benefits and the aftertax cost savings to determine the total annual benefits.

Year	Tax Shield Benefits from Depreciation	After Tax Cost Savings	Total Annuity Benefits
1	13686	$42,900.00	$56,586.00
2	27818	$36,400.00	$64,218.00
3	15274	$35,100.00	$50,374.00
4	9484	$33,800.00	$43,284.00
5	11270	$31,850.00	$43,120.00
6	5684	$24,700.00	$30,384.00

Compute the present value of the total annual benefits

Total Annuity Benefits	Present Value Factor 12%	Present Value
$56,586.00	0.893	$50,531.30
$64,218.00	0.797	$51,181.75
$50,374.00	0.712	$35,866.29
$43,284.00	0.636	$27,528.62
$43,120.00	0.567	$24,449.04
$30,384.00	0.507	$15,404.69
Present value of incremental Benefits		$204,961.68

k-1. Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e)

Present value of incremental Benefits		204962
Net cost of the new equipment		239346
Net present value		-34384