Chapter 12: The Capital Budgeting Decision
12-50
d. Net Present Value
Cash Flow Present
Year (inflows) PVIF at 12% Value
1 $132,200 .893 $118,055
2 126,120 .797 100,518
3 96,672 .712 68,830
33. Replacement decision analysis (LO4) Hercules Exercise Equipment Co. purchased a
computerized measuring device two years ago for $60,000. The equipment falls into the
five-year category for MACRS depreciation and can currently be sold for $23,800.
A new piece of equipment will cost $150,000. 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
Cash Savings
1 ………..
$57,000
2 ………..
49,000
3 ………..
47,000
4 ………..
45,000
5 ………..
42,000
6 ………..
31,000
The firm’s tax rate is 35 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?
Chapter 12: The Capital Budgeting Decision
12-51
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 aftertax benefits of the cost savings.
j. Add the depreciation tax shield benefits and the aftertax cost savings, and determine
the present value. (See Table 12–17 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?
12–33. Solution:
Hercules Exercise Equipment Co.
a.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $60,000 .200 $12,000
2 60,000 .320 19,200
Total depreciation to date $31,200
Purchase price $60,000
– Total depreciation to date 31,200
Book value $28,800
Chapter 12: The Capital Budgeting Decision
12-52
Tax benefit $ 1,750
d. Sales price of the old equipment $ 23,800
12–33. (Continued)
f. Depreciation schedule on the new equipment.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $150,000 .200 $ 30,000
2 150,000 .320 48,000
g. Depreciation schedule for the remaining years of the old
equipment.
Chapter 12: The Capital Budgeting Decision
12-53
Percentage
Depreciation Depreciation Annual
Year* Base (Table 12-9) Depreciation
1 $60,000 .192 $11,520
* The next four years represent the last four years on the old
equipment.
12–33. (Continued)
h. Incremental depreciation and tax shield benefits.
(1)
(2)
(3)
(4)
(5)
(6)
Year
Depreciation
on new
Equipment
Depreciation
on old
Equipment
Incremental
Depreciation
Tax
Rate
Tax
Shield
Benefits
1
$30,000
$11,520
$18,480
.35
$ 6,468
2
48,000
6,900
41,100
.35
14,385
3
28,800
6,900
21,900
.35
7,665
4
17,250
3,480
13,770
.35
4,819
5
17,250
17,250
.35
6,038
6
8,700
8,700
.35
3,045
i. Aftertax cost savings
Chapter 12: The Capital Budgeting Decision
12-54
Year
Savings
(1-Tax Rate)
After tax
Savings
1
$57,000
.65
$37,050
2
49,000
.65
31,850
3
47,000
.65
30,550
4
45,000
.65
29,250
5
42,000
.65
27,300
6
31,000
.65
20,150
12–33. (Continued)
j. Present value of the total incremental benefits.
(1)
(2)
(3)
(4)
(5)
(6)
Year
Tax Shield
Benefits
from
Depreciation
After
Tax Cost
Savings
Total
Annual
Benefits
Present
Value
Factor
12%
Present
Value
1
$ 6,468
$37,050
$43,518
.893
$ 38,862
2
14,385
31,850
46,235
.797
36,849
3
7,665
30,550
38,215
.712
27,209
4
4,819
29,250
34,069
.636
21,668
5
6,038
27,300
33,338
.567
18,903
6
3,045
20,150
23,195
.507
11,760
Present value of incremental benefits
$155,251
k. Present value of incremental benefits $155,251
Chapter 12: The Capital Budgeting Decision
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COMPREHENSIVE PROBLEM
Lancaster Corporation (replacement decision analysis) (LO4) The Lancaster Corporation
purchased a piece of equipment three years ago for $250,000. It has an asset depreciation range
(ADR) midpoint of eight years. The old equipment can be sold for $97,920.
A new piece of equipment can be purchased for $360,000. It also has an ADR of eight years.
Assume the old and new equipment would provide the following operating gains (or losses)
over the next six years.
Year
New Equipment
Old Equipment
1 …………
$100,000
$36,000
2 …………
86,000
26,000
3 …………
80,000
19,000
4 …………
72,000
18,000
5 …………
62,000
16,000
6 …………
43,000
(9,000)
The firm has a 36 percent tax rate and a 9 percent cost of capital. Should the new equipment
be purchased to replace the old equipment?
CP 12-1. Solution:
Replacement Decision Analysis
Lancaster Corporation
Book Value of Old Equipment
(ADR of 8 years indicates the use of the 5-year MACRS
schedule)
Year
Depreciation
Base
Percentage
Depreciation
(Table 12-9)
Annual
Depreciation
1
$250,000
.200
$ 50,000
2
250,000
.320
80,000
3
250,000
.192
48,000
Total depreciation to date
$178,000
Chapter 12: The Capital Budgeting Decision
12-56
CP 12-1. (Continued)
Tax Obligation on the Sale
Sales price $97,920
Cash Inflow From the Sale of the Old Equipment
Sales price $97,920
Net Cost of the New Equipment
(ADR of 8 years indicates the use of 5-year MACRS Schedule)
Year
Depreciation
Base
Percentage
Depreciation
(Table 12-9)
Annual
Depreciation
1
$360,000
.200
$ 72,000
2
360,000
.320
115,200
3
360,000
.192
69,120
4
360,000
.115
41,400
5
360,000
.115
41,400
6
360,000
.058
20,880
$360,000
Chapter 12: The Capital Budgeting Decision
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CP 12-1. (Continued)
Depreciation Schedule for the Remaining Years of the Old
Equipment.
Year*
Depreciation
Base
Percentage
Depreciation
(Table 12-9)
Annual
Depreciation
1
$250,000
.115
$28,750
2
250,000
.115
28,750
3
250,000
.058
14,500
*The next three years represent the last three years of the old
equipment.
Incremental Depreciation and Tax Shield Benefits.
(1)
(2)
(3)
(4)
(5)
(6)
Year
Depreciation
on new
Equipment
Depreciation
on old
Equipment
Incremental
Depreciation
Tax
Rate
Tax
Shield
Benefits
1
$ 72,000
$28,750
$43,250
.36
$15,570
2
115,200
28,750
86,450
.36
31,122
3
69,120
14,500
54,620
.36
19,663
4
41,400
41,400
.36
14,904
5
41,400
41,400
.36
14,904
6
20,880
20,880
.36
7,517
Aftertax cost savings
New
Equipment
Old
Equipment
Cost
Savings
(1 – Tax
Rate)
Aftertax
Savings
$100,000
$36,000
$64,000
.64
$40,960
86,000
26,000
60,000
.64
38,400
80,000
19,000
61,000
.64
39,040
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72,000
18,000
54,000
.64
34,560
62,000
16,000
46,000
.64
29,440
43,000
(9,000)
52,000
.64
33,280
CP 12-1. (Continued)
Present value of the total incremental benefits.
(1)
(2)
(3)
(4)
(5)
(6)
Year
Tax Shield
Benefits
from
Depreciation
After Tax
Cost
Savings
Total
Annual
Benefits
Present
Value
Factor
9%
Present
Value
1
$15,570
$40,960
$56,530
.917
$ 51,838
2
31,122
38,400
69,522
.842
58,538
3
19,663
39,040
58,703
.772
45,319
4
14,904
34,560
49,464
.708
35,021
5
14,904
29,440
44,344
.650
28,824
6
7,517
33,280
40,797
.596
24,315
Present value of incremental Benefits
$243,855
Net Present Value
Present value of incremental benefits $243,855