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Lodi Fabrication is evaluating a proposal to purchase a new turbine to replace a less efficient machine presently in use. The cost of the new equipment at time 0, including delivery and installation, is $450,000. If it is purchased, Lodi will incur costs of $25,000 to remove the present equipment and revamp its facilities. This $25,000 is tax deductible at time 0.

Depreciation on the new machine for tax purposes will be allowed as follows: year 1, $90,000; year 2, $157,500; and in each of years 3 through 5, $67,500 per year. The existing equipment has a book and tax value of $250,000 and a remaining useful life of 10 years. However, the existing equipment can be sold for only $100,000 and is being depreciated for book and tax purposes using the straight-line method over its actual life.

Management has provided you with the following comparative manufacturing cost data.

	Present Equipment	New Equipment
Annual capacity (units)	900,000	900,000
Annual costs:
Labor	$ 67,500	$ 56,000
Depreciation	22,500	31,000
Other (all cash)	108,000	45,000
Total annual costs	$ 198,000	$ 132,000

The existing equipment is expected to have a salvage value equal to its removal costs at the end of 10 years. The new equipment is expected to have a salvage value of $135,000 at the end of 10 years, which will be taxable, and no removal costs. No changes in working capital are required with the purchase of the new equipment. The sales force does not expect any changes in the volume of sales over the next 10 years. The companys cost of capital is 18 percent, and its tax rate is 20 percent. Use Exhibit A.8.

Required:

Calculate the removal costs of the existing equipment net of tax effects.

Compute the depreciation tax shield.

Note: Round PV factor to 3 decimal places.

Compute the annual forgone tax benefits of the old equipment.

Calculate the cash inflow, net of taxes, from the sale of the new equipment in year 10.

Calculate the tax benefit arising from the loss on the old equipment.

Compute the annual differential cash flows arising from the investment in years 1 through 10.

Compute the net present value of the project.

Note: Round your intermediate values to the nearest whole dollars. Round PV factor to 3 decimal places. Negative amounts should be indicated by a minus sign.

	a. Equipment removal net of tax effects b. Depreciation tax shield c. Forgone tax benefits d. Gain from salvage of new equipment e. Tax benefit arising from loss on old equipment f. Differential cash flows g. Net present value

Exhibit A.8:

Present Value of $1

Year	1/2%	1%	2%	4%	5%	6%	8%	10%	12%	14%	15%	16%	18%	20%	22%	24%	25%	30%	35%	40%
1	0.995	0.990	0.980	0.962	0.952	0.943	0.926	0.909	0.893	0.877	0.870	0.862	0.847	0.833	0.820	0.806	0.800	0.769	0.741	0.714
2	0.990	0.980	0.961	0.925	0.907	0.890	0.857	0.826	0.797	0.769	0.756	0.743	0.718	0.694	0.672	0.650	0.640	0.592	0.549	0.510
3	0.985	0.971	0.942	0.889	0.864	0.840	0.794	0.751	0.712	0.675	0.658	0.641	0.609	0.579	0.551	0.524	0.512	0.455	0.406	0.364
4	0.980	0.961	0.924	0.855	0.823	0.792	0.735	0.683	0.636	0.592	0.572	0.552	0.516	0.482	0.451	0.423	0.410	0.350	0.301	0.260
5	0.975	0.951	0.906	0.822	0.784	0.747	0.681	0.621	0.567	0.519	0.497	0.476	0.437	0.402	0.370	0.341	0.328	0.269	0.223	0.186
6	0.971	0.942	0.888	0.790	0.746	0.705	0.630	0.564	0.507	0.456	0.432	0.410	0.370	0.335	0.303	0.275	0.262	0.207	0.165	0.133
7	0.966	0.933	0.871	0.760	0.711	0.665	0.583	0.513	0.452	0.400	0.376	0.354	0.314	0.279	0.249	0.222	0.210	0.159	0.122	0.095
8	0.961	0.923	0.853	0.731	0.677	0.627	0.540	0.467	0.404	0.351	0.327	0.305	0.266	0.233	0.204	0.179	0.168	0.123	0.091	0.068
9	0.956	0.914	0.837	0.703	0.645	0.592	0.500	0.424	0.361	0.308	0.284	0.263	0.225	0.194	0.167	0.144	0.134	0.094	0.067	0.048
10	0.951	0.905	0.820	0.676	0.614	0.558	0.463	0.386	0.322	0.270	0.247	0.227	0.191	0.162	0.137	0.116	0.107	0.073	0.050	0.035
11	0.947	0.896	0.804	0.650	0.585	0.527	0.429	0.350	0.287	0.237	0.215	0.195	0.162	0.135	0.112	0.094	0.086	0.056	0.037	0.025
12	0.942	0.887	0.788	0.625	0.557	0.497	0.397	0.319	0.257	0.208	0.187	0.168	0.137	0.112	0.092	0.076	0.069	0.043	0.027	0.018
13	0.937	0.879	0.773	0.601	0.530	0.469	0.368	0.290	0.229	0.182	0.163	0.145	0.116	0.093	0.075	0.061	0.055	0.033	0.020	0.013
14	0.933	0.870	0.758	0.577	0.505	0.442	0.340	0.263	0.205	0.160	0.141	0.125	0.099	0.078	0.062	0.049	0.044	0.025	0.015	0.009
15	0.928	0.861	0.743	0.555	0.481	0.417	0.315	0.239	0.183	0.140	0.123	0.108	0.084	0.065	0.051	0.040	0.035	0.020	0.011	0.006

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