Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $92,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $41,800. A new piece of equipment will cost $245,000. 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. calculate your final answer using the formula and financial calculator methods.

Year Cash Savings

1 68,000

2 58,000

3 56,000

4 54,000

5 51,000

6 40,000

The firm's tax rate is 25 percent and the cost of capital is 13 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? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

c. What is the tax benefit from the sale? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

d. What is the cash inflow from the sale of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

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 Annual Depreciation

1

2

3

4

5

6

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 Annual Depreciation

1

2

3

4

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 RateTax Shield Benefits

1

2

3

4

5

6

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

2

3

4

5

6

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.)

Year Tax Shield Benefits from Depreciation After Tax Cost Savings Total Annual Benefits

1

2

3

4

5

6

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). (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to the nearest whole dollar.)

Answer 1

a.)  Now the equpiment follows 5 year MACRS depreciation, so, Depreciation charged for 2 years and the book value is :-

Under MACRS depreciation, the depreciation is charged on the original purchase price and Book value is Value after depreciation - depreciation.

We are given that Purchase price is $92000

Year	Rate of Depreciation	Depreciation in $	Book Value in $
1	20%	92000*20/100= 18400	92000-18400 = 73600
2	32%	92000*32/100 = 29440	73600-29440 = 44160

Thus, Book value after 2 years is $44160

b.) Book Value = $44160 , Sale value = $41800 , Tax rate = 25%

Loss = Book value- Sale Value

= $44160- $41800

= $ 2360

Tax loss on sale = $2360 *(1-.25) = $ 1770

c.) Book Value = $44160 , Sale value = $41800 , Tax rate = 25%

Loss = Book value- Sale Value

= $44160- $41800

= $ 2360

Tax Saving on loss on sale = $2360 * 25/100 = $590

d.) Cash inflow on sale of old machine shall be the sale price as well as the tax saved on loss on sale

Cash inflow = $41800+ $590

= $ 42390

e.) Net cost of new equipment is = Purchase price of new equipment - Sale value of old equipment - tax saving on loss on sale

= $ 245000- $41800 - $590

= $ 202610