Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $220,000 and sell its old low-pressure glueball, which is fully depreciated, for $40,000. The new equipment has a 10-year useful life and will save $48,000 a year in expenses. The opportunity cost of capital is 10%, and the firm’s tax rate is 21%.

What is the equivalent annual saving from the purchase if Gluon can depreciate 100% of the investment immediately. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Solution :-

Year 0 Cash flow :-

Purchase Cost = - $220,000

After tax Salvage value of Old Glueball = $40,000 * ( 1 - 0.21 ) = $31,600

Now Depreciation tax Shield = ( $220,000 * 0.21 ) = $46,200

Now Net Cash flow at Year 0 = - $220,000 + $31,600 + $46,200 = - $142,200

Now Year 1 to 10 Cash flows :-

Annual Savings = $48,000

Depreciation = 0 ( As fully Depreciated at time of Purchase )

Now Taxable Saving = $48,000

After tax Saving = $48,000 * ( 1 - 0.21 ) = $37,920

There Net Cash flow at Year 1 - 10 = $37,920

Now Equivalent Annual Saving =

= [ - $142,200 + $37,920 * ( P/A , 10% , 10 ) ] * ( A/P , 10% , 10 )

= [ - $142,200 + ( $37,920 * 6.1446 ) ] * 0.1627

= $14,777.61

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