Question

your highly successful software company is considering adding a new software title to your list. If you add the new product, it will use the full capacity of your full duplicating machines that you planned on using for your flagship product, "Battlin Bobby". You had previously planned on using the unused capacity to start selling "BB" on the west coast in two years. Eventually, you would have had to purchase additional duplicating machines 10 years from today,but since oru new product will use the extra capacity, this will rquire moving this puchase up to 2 years from today. If the new machine will cost $100,000 and will depreicate stright-line over a five year period to zero salvage value, your marginal tax rate is 32 percent, and your cost of capital is 12 percent, what is the opportunity cost associated with using the unused capacity for the new product?

Answer 1

Opportunity cost is the difference in PV terms in having to pay this in two years versus 10 years:

-78,165.36 * (1/1.12)² – (-78,165.36*(1/1.12)¹⁰ = -37,145.79

	1	2	3	4	5	6
Depreciation	10,000	20,000	20,000	20,000	20,000	10,000
Tax rate	*.32	*.32	*.32	*.32	*.32	*.32
Tax shield from depreciation	3200	6400	6400	6400	6400	3200
PV of tax shield	2875.14	5102.04	4555.39	4067.32	3631.53	1621.22
Sum of PV of tax shields	21,834.64