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Taxes: Present Value of the Incremental Benefits

Graphic Systems purchased a computerized measuring device two years ago for $80,000. It falls into the five-year category for MACRS depreciation. The equipment can currently be sold for $28,400. A new piece of equipment will cost $210,000. It also falls into the five-year category for MACRS depreciation.

Assume the new equipment would provide the following stream of added cost savings for the next six years.

Year Cost Savings
1 $76,000
2 66,000
3 62,000
4 60,000
5 56,000
6 42,000

The tax rate is 34 percent and the cost of capital is 12 percent.

a.) What is the book value of the old equipment?
b.) What is the tax loss on the sale of the old equipment?
c.) What is the tax benefit from the sale?
d.) What is the cash inflow from the sale of the old equipment?
e.) What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)
f.) Determine the depreciation schedule for the new equipment.
g.) Determine the depreciation schedule for the remaining years of the old equipment.
h.) Determine the incremental depreciation between the old and new equipment and the related tax shield benefits.
i.) Compute the after-tax benefits of the cost savings.
j.) Add the depreciation tax shield benefits and the after-tax cost savings, and determine the present value. (See Table 12-17 on page 372 as an example.)
k.) Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e). Should the replacement be undertaken?

Solution Summary

This solution provides a detailed, step by step response which shows how to compute the present value of incremental benefits and other financial based calculations. All calculations have been computed in an attached Excel file. By clicking directly onto the cells of the spreadsheet, it shows which functions need to be employed in order to derive the desired values.

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