Problem 12-31 (Algo) Replacement decision analysis [LO12-4]

Hercules Exercise Equipment Company purchased a computerized measuring device two years ago for $70,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $30,800. A new piece of equipment will cost $160,000. 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 1212. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

year 1: 68,000 / year 2: 60,000 / year 3 : 58,000 / year 4 : 56,000/ year 5 : 53,000 / year 6 : 42,000

The firms tax rate is 25 percent and the cost of capital is 11 percent.

a. What is the book value of the old equipment?

b. What is the tax loss on the sale of the old equipment?

c. What is the tax benefit from the sale?

d. What is the cash inflow from the sale of the old equipment?

e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)

f. Determine the depreciation schedule for the new equipment.

Depreciation Base and Percentage Depreciation and Annual Depreciation for year 1 to year 6.

g. Determine the depreciation schedule for the remaining years of the old equipment.

Depreciation Base and Percentage Depreciation and Annual Depreciation for year 1 to year 4.

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

Depreciation on New Equipment

Depreciation on Old Equipment

Incremental Depreciation

Tax Rate

Tax Shield Benefits

this is for year 1 to 6 .

i. Compute the aftertax benefits of the cost savings.

Year

Savings

(1 Tax Rate)

Aftertax Savings

this is for year 1 to 6 .

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

Year

Tax Shield Benefits from Depreciation

Aftertax Cost Savings

Total Annual Benefits

j-2. Compute the present value of the total annual benefits. present value ?

k-1. Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e). net present value ?

k-2. Should the replacement be undertaken?

multiple choice

• Yes

• No