Question

A division of Raytheon owns a 5-year-old turret lathe used to manufacture fabricated metal products that was purchased for $96,000 and now has a financial reporting (non-tax) book value of $24,000. It has been depreciated for tax purposes as MACRS-GDS 7-year property. It has a current market value of $18,000. The expected decline in market value is $3,000 per year from this point forward to a minimum of $3,000. O&M costs are $8,000 per year. Additional capability is needed. If the old lathe is kept, that new capability will be contracted out for $13,000, assumed payable at the end of each year. A new turret lathe has the increased capability to fulfill all needs, replacing the existing turret lathe and requiring no outside contracting. It can be purchased for $65,000 and will have an expected life of 8 years. Its market value is expected to be $65,000(0.7t) at the end of year t. Annual O&M costs are expected to equal $10,000. If the after-tax MARR is 9 percent, the tax rate is 40 percent, and the planning horizon is 8 years, determine whether to keep and use a contractor or to sell and buy new.

Answer 1

MACRS 7 years rates				Initial value	96000
Recovery year	7 year	Dept. Amount		Tax vaue current	21417.60
1	14.29	13718.40
2	24.49	23510.40		Cash flow(contracting)
3	17.49	16790.40		year	0	1	2	3	4	5	6	7	8
4	12.49	11990.40		O & M costs		8000.00	8000.00	8000.00	000.00	8000.00	8000.00	8000.00	8000.00
5	8.93	8572.80		Contracting costs		13000.00	13000.00	13000.00	13000.00	13000.00	13000.00	13000.00	13000.00
6	8.92	8563.20		Depreciation		8563.20	8572.80	4281.60
7	8.93	8572.80		Total costs		29563.20	29572.80	2521.60	21000.00	21000.00	21000.00	21000.00	21000.00
8	4.46	4281.60		Tax saving @ 40%		11825.28	11829.12	10112.64	8400	8400	8400	8400	8400
				Less:Depreciation		8563.20	8572.80	4281.60	0.00	0.00	0.00	0.00	0.00
				Less:salvage value									3000
				Net outward cash flow(costs)		-9174.72	9170.8	1087.36	12600.00	12600.00	12600.00	12600.00	9600.00
Initial value		65000		NPV @ 9%	$60,881.97

Recovery year	7 year	Dept. amount		Salvage value at the end of 8 years		3747.121	(65000*0.7^8)
1	14.29	928.50		Cash flow(buying)
2	24.49	15918.50		year	0	1	2	3	4	5	6	7	8
3	17.49	11368.50		O&M Costs		10000.00	10000.00	10000.00	1000.00	10000.00	10000.00	10000.00	10000.00
4	8.93	5804.50		Depreciation		9288.50	15918.50	11368.50	8118.50	5804.50	5798.00	5804.50	2899.00
5	12.49	8118.50		Contracting costs		0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00
6	8.92	5798.00		Total costs		19288.50	25918.50	21368.50	1811.50	15804.50	15798.00	15804.50	12899.00
7	8.93	5804.50		Tax saving@40%		7715.4	10367.4	8547.4	7247.4	6321.8	6319.2	6321.8	5159.6
8	4.46	2899.00		Less:Depreciation		9288.50	15918.50	11368.50	8118.50	5804.50	5798.00	5804.50	2899.00
				Less:gain on sale of old turrent	19367.04
				Less:salvage value									3747.121
				Add;tax									1498.848
Sale of old lathe		18000.00		Add:new lathe	65000.00
Tax value		21417.60		Net outward cash flow(costs)	45632.96	2284.6	-367.4	1452.6	2752.6	3678.2	3680.8	3678.2	2592.128
Loss		-3417.60
Tax saving		1367.04		NPV @9%	$58,389.70
Total gain		19367.04