Hercules Exercise Equipment Co purchased a computerized meas

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $86,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $38,800.

     A new piece of equipment will cost $270,000. 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.

What is the book value of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

What is the tax loss on the sale of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

What is the tax benefit from the sale? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

What is the cash inflow from the sale of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

Determine the depreciation schedule for the new equipment. (Round the depreciation base and annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)

Determine the depreciation schedule for the remaining years of the old equipment. (Round the depreciation base and annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)

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.)

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.)

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.)

Compute the present value of the total annual benefits. (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

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.)

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $86,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $38,800.

A new piece of equipment will cost $270,000. 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.

Solution

Answer a Calculation of book value of the old equipment Cost of old equipment $86,000.00 Less : Depreciation for 1st year @ 20% $17,200.00 Book value at the end of 1st Year $68,800.00 Less : Depreciation for 2nd year @ 32% $22,016.00 Book value of the old equipment $46,784.00 Answer b Tax loss on old equipment = Sale value of old equipment * Tax rate Tax loss on old equipment = $38800 * 30% = $11,640 Answer c Tax benefit on old equipment = Book value of old equipment * Tax rate Tax benefit on old equipment = $46,784 * 30% = $14,035.20 Answer d Cash inflow from sale of old equipment = Sale value + Tax benefit - Tax loss Cash inflow from sale of old equipment = $38800 + $14035.20 - $11640 Cash inflow from sale of old equipment = $41,195.20 Answer e Net cost of new equipment = Cost of new equipment - Cash inflow from sale of old equipment Net cost of new equipment = $270000 - $41,195.20 = $2,28,804.80 Answer f Depreciation schedule of new equipment Year Depreciation base Percentage depreciation Annual Depreciation 1 $270,000.00 20% $54,000.00 2 $270,000.00 32% $86,400.00 3 $270,000.00 19.20% $51,840.00 4 $270,000.00 11.52% $31,104.00 5 $270,000.00 11.52% $31,104.00 6 $270,000.00 5.76% $15,552.00 Answer g The depreciation schedule for the remaining years of the old equipment Year Depreciation base Percentage depreciation Annual Depreciation 1 $86,000.00 19.20% $16,512.00 2 $86,000.00 11.52% $9,907.20 3 $86,000.00 11.52% $9,907.20 4 $86,000.00 5.76% $4,953.60 Answer h Determination of the incremental depreciation between the old and new equipment and the related tax shield benefits. Year Depreciation on new equipment Depreciation on old equipment Incremental depreciation Tax rate Tax shield benefits 1 $54,000.00 $16,512.00 $37,488.00 30% $11,246.40 2 $86,400.00 $9,907.20 $76,492.80 30% $22,947.84 3 $51,840.00 $9,907.20 $41,932.80 30% $12,579.84 4 $31,104.00 $4,953.60 $26,150.40 30% $7,845.12 5 $31,104.00 0 $31,104.00 30% $9,331.20 6 $15,552.00 0 $15,552.00 30% $4,665.60 Answer i Compute the aftertax benefits of the cost savings. Year Savings (1-tax rate) Aftertax Savings 1 $65,000.00 0.7 $45,500.00 2 $55,000.00 0.7 $38,500.00 3 $53,000.00 0.7 $37,100.00 4 $51,000.00 0.7 $35,700.00 5 $48,000.00 0.7 $33,600.00 6 $37,000.00 0.7 $25,900.00 Answer j-1 Year Tax shield benefits from Depreciation After tax cost savings Total Annual benefits 1 $11,246.40 $45,500.00 $56,746.40 2 $22,947.84 $38,500.00 $61,447.84 3 $12,579.84 $37,100.00 $49,679.84 4 $7,845.12 $35,700.00 $43,545.12 5 $9,331.20 $33,600.00 $42,931.20 6 $4,665.60 $25,900.00 $30,565.60 Answer j-2 Compute the present value of the total annual benefits Year Total Annual benefits Discount factor @ 11% Present Value 1 $56,746.40 0.900900901 $51,122.88 2 $61,447.84 0.811622433 $49,872.45 3 $49,679.84 0.731191381 $36,325.47 4 $43,545.12 0.658730974 $28,684.52 5 $42,931.20 0.593451328 $25,477.58 6 $30,565.60 0.534640836 $16,341.62 Present value of the total annual benefits $207,824.51 Answer k-1 Net present value = present value of the incremental benefits - net cost of the new equipment Net present value = $2,07,824.51 - $2,28,804.80 Net present value = -$20,980.29