Question

The Woodruff Corporation purchased a piece of equipment three years ago for $211,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $93,500.

A new piece of equipment can be purchased for $324,500. It also has an ADR of eight years.

Assume the old and new equipment would provide the following operating gains (or losses) over the next six years:

Year New Equipment Old Equipment 1............... $82,000 $26,000 2............... 76,250 16,250 3............... 69,750 7,750 4............... 58,250 6,750 5............... 50,000 7,000 6............... 43,500 -7,500

The firm has a 25 percent tax rate and a 9 percent cost of capital.

1. What is the net cost of the new equipment? Round your solution to two decimal places.

2. What is the present value of incremental benefits? Round your solution to two decimal places.

Answer 1

Need to understand depreciation method we used in details.

Fact :ADR was replaced by the ACRS system, and then in turn by the MACRS as part of the Tax Reform Act of 1986. MACRS allows for greater accelerated depreciation over longer time periods. Today that desk can be depreciated over seven to 10 years.

Please see the below deprciation Calculation Method:

Depreciation in 1st Year =(Cost )×(1/ Useful Life) × A × Depreciation Convention

Depreciation in Subsequent Years =(Cost − Depreciation in Previous Years) ×(1/ Recovery Period) × A

As a result :

Year	As per Macrs Depreciation %
7-year
1	14.29
2	24.49
3	17.49
4	12.49
5	8.93
6	8.92
7	8.93
8	4.46

Please see the below table comparison and calculation to understand both old and new project

	Intial Investment	Y1	y2	Y3	Y4	Y5	Y6
Old Method	211,000.00
npv	45,346.32	23,853.21	13,677.30	5,984.42	4,781.87	4,549.52	(7,500.00)
Cash Flow + exclude Depreciation		26,000.00	16,250.00	7,750.00	6,750.00	7,000.00	(7,500.00)
PAT		(4,151.90)	(35,423.90)	(29,153.90)	(19,603.90)	(11,842.30)	(26,321.20)
Tax
Depreciation		30,151.90	51,673.90	36,903.90	26,353.90	18,842.30	18,821.20
Cash Before deducting Depreciaton and Tax		26,000.00	16,250.00	7,750.00	6,750.00	7,000.00	(7,500.00)
Loss of the Project	(126,497.10)
				Y0	Y1	Y2	Y3	Y4	Y5	Y6
New Machine				-324500
Sold Old Machine and Cash Flow Beofre Time value of money				93500	73092.7625	76250	66501.2625	53820.01	44744.46	39861.35
Cash Flow / Loss					67057.5803	64178.0995	51351.1763	38127.45	29080.83	23768.02
IRR	10%
PAT					26721.7125	-3220.05	9746.2125	13289.96	15766.61	10915.95
Tax					8907.2375		3248.7375	4429.988	5255.538	3638.65
Depreciation					46371.05	79470.05	56755.05	40530.05	28977.85	28945.4
Cash Before deducting Depreciaton and Tax					82000	76250	69750	58250	50000	43500
Profit of the project	166720.4
Present Value of incremental Benefit	321,716.84	NPV pf New Project -NPV old Project
NPV Old Project	45,346.32
NPV New Project (Considered Sold Euipment)	$ 367063.1609

Net cost of the new project (excluding Depreciation ) = Project cost + Tax Paid

= 324500 + 25480

= $ 349980

Kindly let us know if further queries.

Thanks.