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Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the...

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Gluon Inc. is considering the purchase of a new high pressureglueball. It can purchase the glueball for $160,000 and sell itsold low-pressure glueball, which is fully depreciated, for $28,000.The new equipment has a 10-year useful life and will save $36,000 ayear in expenses. The opportunity cost of capital is 11%, and thefirm’s tax rate is 40%. What is the equivalent annual savings fromthe purchase if Gluon uses straight-line depreciation? Assume thenew machine will have no salvage value.

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4.1 Ratings (632 Votes)

Time line 0 1 2 3 4 5 6 7 8 9 10
Proceeds from sale of existing asset =selling price* ( 1 -tax rate) 16800
Tax shield on existing asset book value =Book value * tax rate 0
Cost of new machine -160000
=Initial Investment outlay -143200
Savings 36000 36000 36000 36000 36000 36000 36000 36000 36000 36000
-Depreciation Cost of equipment/no. of years -16000 -16000 -16000 -16000 -16000 -16000 -16000 -16000 -16000 -16000
=Pretax cash flows 20000 20000 20000 20000 20000 20000 20000 20000 20000 20000
-taxes =(Pretax cash flows)*(1-tax) 12000 12000 12000 12000 12000 12000 12000 12000 12000 12000
+Depreciation 16000 16000 16000 16000 16000 16000 16000 16000 16000 16000
=after tax operating cash flow 28000 28000 28000 28000 28000 28000 28000 28000 28000 28000
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 0
Total Cash flow for the period -143200 28000 28000 28000 28000 28000 28000 28000 28000 28000 28000
Discount factor= (1+discount rate)^corresponding period 1 1.11 1.2321 1.367631 1.5180704 1.6850582 1.8704146 2.07616 2.30454 2.558037 2.839421
Discounted CF= Cashflow/discount factor -143200 25225.225 22725.4281 20473.359 18444.467 16616.637 14969.943 13486.44 12149.9 10945.89 9861.165
NPV= Sum of discounted CF= 21698.49631
EAS 3684.43564
Year or period 0 1 2 3 4 5 6 7 8 9 10
EAS 3684.4356 3684.43564 3684.4356 3684.4356 3684.4356 3684.4356 3684.436 3684.44 3684.436 3684.436
Discount factor= (1+discount rate)^corresponding period 1.11 1.2321 1.367631 1.5180704 1.6850582 1.8704146 2.07616 2.30454 2.558037 2.839421
Discounted CF= Cashflow/discount factor 3319.3114 2990.37062 2694.0276 2427.0519 2186.5332 1969.8498 1774.639 1598.77 1440.337 1297.601
NPV= 21698.49631
EAS is equivalent yearly CF with same NPV = 3684.43564

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Transcribed Image Text

Gluon Inc. is considering the purchase of a new high pressureglueball. It can purchase the glueball for $160,000 and sell itsold low-pressure glueball, which is fully depreciated, for $28,000.The new equipment has a 10-year useful life and will save $36,000 ayear in expenses. The opportunity cost of capital is 11%, and thefirm’s tax rate is 40%. What is the equivalent annual savings fromthe purchase if Gluon uses straight-line depreciation? Assume thenew machine will have no salvage value.

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