Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $120,000 and sell its old low-pressure glueball, which is fully depreciated, for $20,000. The new equipment has a 10-year useful life and will save $28,000 a year in expenses. The opportunity cost of capital is 12%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value.

Answer 1

1]	Cost of the new pressure glueball	$      1,20,000
	Less: After tax sale value of old glueball = 20000*(1-40%) =	$          12,000
	Net initial investment	$      1,08,000
	EAW of net initial investment = -108000*0.12*1.12^10/(1.12^10-1) =	$ -19,114.29
2]	Annual after tax savings in expenses = 28000*(1-40%) =	$    16,800.00
3]	Tax shielld on depreciation = (120000/10)*40% =	$      4,800.00
4]	Equivalent annual savings = -19114.29+16800+4800 =	$      2,485.71