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# Equivalent annual savings

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Hi,

Question below:

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 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. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent annual savings \$________________

#### Solution Preview

Solution:

Step 1: To compute the annual after-tax cash flows

Initial investment in year 0:
Purchase cost of new equipment \$(220,000)
Less: After-tax salvage value of old equipment \$24,000
[\$40,000 * (1-.40)]
Net cash outflow in Year 0 \$(196,000)

Annual operating cash flows: Years 1 till ...

#### Solution Summary

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 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. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent annual savings \$________________

\$2.49