Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $62,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $26,800. A new piece of equipment will cost $152,000. 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		$	64,000
2			56,000
3			54,000
4			52,000
5			49,000
6			38,000

The firm’s tax rate is 25 percent and the cost of capital is 14 percent.

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	Dep. on New	Dep. on Old	Incre. Dep.	Tax Rate	Tax 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	64000
2	56000
3	54000
4	52000
5	49000
6	38000

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 Dep.	Aftertax 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

*Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $62,000.

*The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $26,800

*A new piece of equipment will cost $152,000. 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

Years	Cash Savings
1	64,000
2	56,000
3	54,000
4	52,000
5	49,000
6	38,000

The firm’s tax rate is 25 percent and the cost of capital is 14 percent.

A. Determine the incremental depreciation between the old and new equipment and the related tax shield benefits.

Years	Dep. On new equip.	Dep. On old equip.	Incremental dep.	Tax rate	Tax shield benefits
1	152000*0.20 =30400	62000*0.1920 =11904	18496	0.25	4624
2	152000*0.32 =48640	62000*0.1152 =7142.4	41497.6	0.25	10374.40
3	152000*0.1920 =29184	62000*0.1152 =7142.4	22041.6	0.25	5510.40
4	152000*0.1152 =17510.4	62000*0.0576 =3571.2	13939.2	0.25	3484.80
5	152000*0.1152 =17510.4	0	17510.4	0.25	4377.60
6	152000*0.0576 =8755.2	0	8755.2	0.25	2188.80

B. Compute the after tax benefits of the cost savings.

Years	Cash Savings	(1-tax rate)	After tax benefits
1	64,000	(1-0.25) =0.75	64000*0.75 =48000
2	56,000	=0.75	56000*0.75 =42000
3	54,000	=0.75	54000*0.75 =40500
4	52,000	=0.75	52000*0.75 =39000
5	49,000	=0.75	49000*0.75 =36750
6	38,000	=0.75	38000*0.75 =28500

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

Years	Tax shield benefit from dep.	After tax cost saving	Total Annual benefits
1	4624	48000	52624
2	10374.40	42000	52374.40
3	5510.40	40500	46010.40
4	3484.80	39000	42484.80
5	4377.60	36750	41127.60
6	2188.80	28500	30688.80

2. Compute the present value of the total annual benefits.

Total Annual benefits	PV factor $1 @ 14%	Present value of Total annual benefit
52624	(1 / 1+ 14%)1 = 0.877	46151.25
52374.40	(1 / 1+ 14%)1 = 0.769	40275.91
46010.40	(1 / 1+ 14%)1 = 0.675	31057.02
42484.80	(1 / 1+ 14%)1 = 0.592	251581
41127.60	(1 / 1+ 14%)1 = 0.519	21345.22
30688.80	(1 / 1+ 14%)1 = 0.456	13994.10
Total of Present value of annual benefit	177974.50

D. Compare the present value of the incremental benefits (c2) to the net cost of the new equipment

Initial investment

New equipment cost = 152000 (outflow)

Net cash received from old equip. = 27540 (inflow)

Net initial investment = 152000 - 27540 = 124460

Net cash received from old equip.

Market value of old equip. = 26800 ( inflow)

Cost of old equip. = 62000

Accumulated dep. Of past 2 years = 62000 * 52% = 32240

Book value of old equip. = 29760

Taxable loss from sale = 26800 - 29760 = 2960

Tax benefit from loss = 2960 * 0.25 = 740 (inflow)

Net cash received from old equip. = 26800 + 740 = 27540 (inflow)

Compare the present value of the incremental benefits (c2) to the net cost of the new equipment = NPV

NPV = present value of the incremental benefits - cost of the new equipment

NPV = 177974.50 - 124460 = $ 53514.50