Question

"A manufacturing firm is considering purchasing a new machine for $216,000. The firm plans on borrowing $108,000 to be paid off in equal payments in 3 years. The interest rate on the loan is 4.3%. The machine is classified as 7-years MACRS. Using the machine will save $68,000 in labor costs each year. The annual O&M costs for the machine are $7,000. The firm plans on using the machine for 5 years after which it will be salvaged for $97,200.
Calculate the taxable income (i.e., income before taxes) for the income statement for year 1 if the firm purchases the machine."

Answer 1

Working notes: For year 1,

(1) Annual labor saving = $68,000

(2) Annual loan repaid ($) = Loan amount / P/A(4.3%, 3) = 108,000 / 2.7594** = 39,139

(3) First cost ($) = 216,000 - 108,000 = 108,000

(4) MACRS depreciation = $108,000 x 14.29%^# = $15,433

Therefore,

Income before tax ($) = Labor saving - Loan repaid - Depreciation - O&M costs

= 68,000 - 39,139 - 15,433 - 7,000

= 6,428

**P/A(r%, N) = [1 - (1 + r)^-N] / r

P/A(4.3%, 3) = [1 - (1.043)^-3] / 0.043 = (1 - 0.8813) / 0.043 = 0.1187 / 0.043 = 2.7594

#From MACRS depreciation table. This method ignores salvage value.