Question

A manufacturing company has some existing semiautomatic production equipment that it is considering replacing. This equipment has a present MV of ​$55 comma 000 and a BV of ​$31 comma 500. It has five more years of depreciation available under MACRS​ (ADS) of ​$7 comma 000 per year for four years and ​$3 comma 500 in year five.​ (The original recovery period was nine​ years.) The estimated MV of the equipment five years from now is ​$18 comma 500. The total annual operating and maintenance expenses are averaging ​$26 comma 000 per year. New automated replacement equipment would then be leased. Estimated annual operating expenses for the new equipment are ​$12 comma 500 per year. The annual leasing costs would be ​$23 comma 900. The MARR​ (after taxes) is 8​% per​ year, tequals40​%, and the analysis period is five years. ​(Remember​: The owner claims​ depreciation, and the leasing cost is an operating​ expense.) Based on an​ after-tax analysis, should the new equipment be​ leased? Base your answer on the IRR of the incremental cash flow.

Answer 1

Answer:

It is a better deal to keep the old equipment

Explanation:

$\left[\begin{array}{cccc}&New&Old&Differential\\ leasing cost&0&-23,000&23,000\\ operarting cost&-26,000&-12,500&-13,500\\ operating income&-26,000&-35,500&9,500\\ tax shield&4,200&0&4,200\\ Result&-21,800&-35,500&13,700\\\end{array}\right]$

each year the new equipment generates a 13,700 adidtional cash outflow

We should check if the cost saving per year at 8% will have a present value lower than the proceed from the sale:

C 13,700.00

time 5

rate 0.08

$13700 \times \frac{1-(1+0.08)^{-5} }{0.08} = PV$

PV $59,076.1377

As the differential cost exceeds the amount of proceed we would get if the old equipment is sold we already conclude we should keep it