Question

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $78,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $34,800. A new piece of equipment will cost $230,000. 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.

Year Cash Savings 1 $ 61,000

2 51,000

3 49,000

4 47,000

5 44,000

6 33,000

The firm’s tax rate is 25 percent and the cost of capital is 10 percent.

c. What is the tax benefit from the sale? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)
d. 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.)
e. 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.)
f. 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.)
g. 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.)
h. 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.)

Answer 1

Solution-

a.
		Percentage
	Depreciation	Depreciation	Annual
Year	Base		Depreciation
1	78,000	0.200	15,600
2	78,000	0.320	24,960
Total depreciation to date		40,560

Purchase Price	78,000
Less: Depreiation to date	40,560
Book value	37,440

b.
Book value	37,440
Sales Price	34,800
Loss on sale	2,640

c.
Loss on sale	2,640
Tax rate	0.25
Tax benefit	660
d.
Sales price of the old equipment	34,800
Add-Tax benefit from the sale	660
Cash inflow from the sale of the old equipment	35,460
e.
Price of the new equipment	230,000
– Cash inflow from the sale of the old equipment	(35,460)
Net cost of the new equipment	194,540

f.Depreciation schedule on the new equipment.
		Percentage
	Depreciation	Depreciation	Annual
Year	Base		Depreciation
1	230,000	0.200	46,000
2	230,000	0.320	73,600
3	230,000	0.192	44,160
4	230,000	0.115	26,450
5	230,000	0.115	26,450
6	230,000	0.058	13,340
			230,000

g.Depreciation schedule for the remaining years of the old equipment
		Percentage
	Depreciation	Depreciation	Annual
Year*	Base		Depreciation
1	78,000	0.192	14,976
2	78,000	0.115	8,970
3	78,000	0.115	8,970
4	78,000	0.058	4,524

h. Incremental depreciation and tax shield benefits.

(1)	(2)	(3)	(4)	(5)	(6)
Year	Depreciation on new Equipment	Depreciation on old Equipment	Incremental Depreciation(2-3)	Tax Rate	Tax Shield Benefits(4*5)
1	46,000	14,976	31,024	0.25	7,756
2	73,600	8,970	64,630	0.25	16,157
3	44,160	8,970	35,190	0.25	8,797
4	26,450	4,524	21,926	0.25	5481
5	26,450		26,450	0.25	6,612
6	13,340		13,340	0.25	3,335