Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $120,000 and sell its old low-pressure glueball, which is fully depreciated, for $20,000. The new equipment has a 10-year useful life and will save $28,000 a year in expenses. The opportunity cost of capital is 12%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Note: I tried $2545.81 and $2545.71, but those answers are showing as wrong.

Answer 1

n= 10 years
Discount rate (i) = 12% or	0.12
New Machine Cost	-120000
Sale of old machine	20000
Tax on sale proceeds(40%*20000)=	-8000
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Initial investment	-108000
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Calculation of Annual free Cash flow
Savings in expenses	28000
less: Depreciation (120000/10)	-12000
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Profit before tax	16000
less: tax @ 40%	-6400
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Profit after tax	9600
Addback : Depreciation	12000
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Annual free cash flow	21600
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Equivalent Annual Annuity formula = Initial Investment * r/ {1- (1/1+r)n) } + Annual free cash flow
(-108000*0.12 /(1-(1/((1+0.12)^10))))+21600
2485.710271
So, Equivalent annual savings is $2485.71

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