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 $300,000. 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		$	68,000
2			58,000
3			56,000
4			54,000
5			51,000
6			40,000

The firm’s tax rate is 30 percent and the cost of capital is 13 percent.

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.)
  

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

k-2. Should the replacement be undertaken?
  

	No
	Yes

Answer 1

					Answer f
Answer e					The depreciation schedule for the new equipment using 5 year MACRS
The net cost of the new equipment					Year	Depreciable value	Depreciation rates	Depreciation
Cost of new equipment	$300,000.00				1	$300,000	20%	$60,000
Less : cash inflow from sale of old equipment	$42,508.00				2	$300,000	32%	$96,000
The net cost of the new equipment	$257,492.00				3	$300,000	19.20%	$57,600
					4	$300,000	11.52%	$34,560
Answer k-1 Compare the present value of the incremental benefits (j)					5	$300,000	11.52%	$34,560
to the net cost of the new equipment (e).					6	$300,000	5.76%	$17,280
Present value of annual benefits	$211,673.86
Less : Net cost of new equipment	$257,492.00				Answer g
Net Present Value	-$45,818.14				The depreciation schedule for the remaining years of the old equipment.
					Year	Depreciable value	Depreciation rates	Depreciation
Answer k-2					1	$92,000	19.20%	$17,664
The answer is No.					2	$92,000	11.52%	$10,598
The replacement of equipment should not be undertaken as the					3	$92,000	11.52%	$10,598
net present value of new equipment is nagative amount.					4	$92,000	5.76%	$5,299
					Answer h
					Determine the incremental depreciation between the old and new equipment
					and the related tax shield benefits.
					Year	Depreciation (New equipment)	Depreciation (Old equipment)	Difference	Tax shield @ 30% of difference
Working					1	$60,000	$17,664	$42,336	$12,701
Calculation of after tax sale value of old equipment					2	$96,000	$10,598	$85,402	$25,620
Cost of old equipment	$92,000.00				3	$57,600	$10,598	$47,002	$14,100
Less : Depreciation for Year 1 [$92000 x 20%]	$18,400.00				4	$34,560	$5,299	$29,261	$8,778
Less : Depreciation for Year 2 [$92000 x 32%]	$29,440.00				5	$34,560		$34,560	$10,368
Book value of old equipment at the time of sale	$44,160.00				6	$17,280		$17,280	$5,184
Less : Sale value	$41,800.00
Loss on sale	$2,360.00				Answer i
Tax benefit @ 30% of loss	$708.00				The aftertax benefits of the cost savings
After tax sale value [Sale value + Tax benefit]	$42,508.00				Year	Cash savings	Tax @ 30% of cash savings	After tax benefits from cost savings
					1	$68,000	$20,400	$47,600
					2	$58,000	$17,400	$40,600
					3	$56,000	$16,800	$39,200
					4	$54,000	$16,200	$37,800
					5	$51,000	$15,300	$35,700
					6	$40,000	$12,000	$28,000
					Answer j-1 Determine the total annual benefits.
					Year	After tax benefits from cost savings	Depreciation Tax shield	Total Annual benefits
					1	$47,600	$12,701	$60,301
					2	$40,600	$25,620	$66,220
					3	$39,200	$14,100	$53,300
					4	$37,800	$8,778	$46,578
					5	$35,700	$10,368	$46,068
					6	$28,000	$5,184	$33,184
					Answer j-2 Compute the present value of the total annual benefits.
					Year	Total Annual benefits	Discount factor @ 13%	Present value of total annual benefits
					1	$60,301	0.884955752	$53,364
					2	$66,220	0.783146683	$51,860
					3	$53,300	0.693050162	$36,940
					4	$46,578	0.613318728	$28,567
					5	$46,068	0.542759936	$25,004
					6	$33,184	0.480318527	$15,939
					Total			$211,674