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Chapter 12: The Capital Budgeting Decision
12-33. Solution:
Hercules Exercise Equipment Co.
a.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
f. Depreciation schedule on the new equipment
Percentage
Depreciation Depreciation Annual
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 12: The Capital Budgeting Decision
Year Base (Table 12-9) Depreciation
g. Depreciation schedule for the remaining years of the old
equipment
Percentage
Depreciation Depreciation Annual
Year* Base (Table 12-9) Depreciation
* 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
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 12: The Capital Budgeting Decision
i. Aftertax cost savings
Year Savings
(1 – Tax
Rate)
Aftertax
Savings
j. Present value of the total incremental benefits
(1) (2) (3) (4) (5) (6)
Year
Tax Shield
Benefits
from
Depreciation
Aftertax
Cost
Savings
Total
Annual
Benefits
Present
Value
Factor
12%
Present
Value
Based on the present value analysis, the equipment should be
replaced.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 12: The Capital Budgeting Decision
Calculator Solution:
Using a financial calculator,
Press the following keys: 2nd, CF, 2nd, Clear.
Calculator displays CF0, press 122,136 +|–, press the Enter key.
Press down arrow, enter 46,762, and press Enter.
Based on the present value analysis, the equipment should be replaced.
COMPREHENSIVE PROBLEM
The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has
an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for
$90,000.
A new piece of equipment can be purchased for $320,000. 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:
New Equipment Old Equipment
1.............. $80,000 $25,000
2.............. 76,000 16,000
3.............. 70,000 9,000
4.............. 60,000 8,000
5.............. 50,000 6,000
6.............. 45,000 (7,000)
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:
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 12: The Capital Budgeting Decision
Woodruff 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
Tax Obligation on the Sale
Cash Inflow from the Sale of the Old Equipment
Net Cost of the New Equipment
Depreciation Schedule of the New Equipment
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 12: The Capital Budgeting Decision
(ADR of 8 years indicates the use of the 5-year MACRS
schedule)
Year
Depreciation
Base
Percentage
Depreciation
(Table 12-9)
Annual
Depreciation
Depreciation Schedule for the Remaining Years of the Old
Equipment
Year*
Depreciation
Base
Percentage
Depreciation
(Table 12-9)
Annual
Depreciation
*The next three years represent the last three years of the old
equipment.
CP 12-1. (Continued)
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
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 12: The Capital Budgeting Decision
Aftertax cost savings
New
Equipment
Old
Equipment
Cost
Savings
(1 – Tax
Rate)
Aftertax
Savings
CP 12-1. (Continued)
Present value of the total incremental benefits.
(1) (2) (3) (4) (5) (6)
Year
Tax Shield
Benefits
from
Depreciation
Aftertax
Cost
Savings
Total
Annuity
Benefits
Present
Value
Factor
9%
Present
Value
Net Present Value
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 12: The Capital Budgeting Decision
Based on the net present value analysis, the equipment should not
be replaced.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
