Dungan Corporation is evaluating a proposal to purchase a new drill press to replace a less efficient machine presently in use. The cost of the new equipment at time 0, including delivery and Installation, is $205,000. If It is purchased, Dungan will incur costs of $5,200 to remove the present equipment and revamp Its facilities. This $5,200 is tax deductible at time 0. Depreciation for tax purposes will be allowed as follows: year 1, $42,000; year 2, $72,000; and in each of years 3 through 5, $32,000 per year. The existing equipment has a book and tax value of $102,000 and a remaining useful life of 10 years. However, the existing equipment can be sold for only $42,000 and is being depreciated for book and tax purposes using the straight-line method over its actual life. Management has provided you with the following comparative manufacturing cost data. Annual capacity (units) Annual costs: Labor Depreciation Other (all cash) Total annual costs The existing equipment is expected to have a salvage value equal to its removal costs at the end of 10 years. The new equipment is expected to have a salvage value of $62,000 at the end of 10 years, which will be taxable, and no removal costs. No changes in working capital are required with the purchase of the new equipment. The sales force does not expect any changes in the volume of sales over the next 10 years. The company's cost of capital is 16 percent, and its tax rate is 25 percent. Use Exhibit A.8. a. b. Required: a. Calculate the removal costs of the existing equipment net of tax effects. b. Compute the depreciation tax shield. (Round PV factors to 3 decimal places.) Present New Equipment Equipment 402,000 402,000 c. Compute the forgone tax benefits of the old equipment. d. Calculate the cash Inflow, net of taxes, from the sale of the new equipment in year 10. e. Calculate the tax benefit arising from the loss on the old equipment. 1. Compute the annual differential cash flows arising from the investment In years 1 through 10. g. Compute the net present value of the project. C. d. $ 27,000 $ 32,500 12,000 50,000 16,000 22,000 $ 90,000 $ 61,000 Equipment removal net of tax effects Depreciation tax shield Forgone tax benefits Gain from salvage of new equipment e. Tax benefit arising from loss on old equipment f. Differential cash flows 9. Net present value Answer is complete but not entirely correct. $ 3,900 $ 52,500 $ 2,550 $ 46,5001 $ 15,000 $ 25,1250 $ 151,900

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Dungan Corporation is evaluating a proposal to purchase a new drill press to replace a less efficient machine presently in use. The
cost of the new equipment at time 0, including delivery and Installation, is $205,000. If It is purchased, Dungan will incur costs of
$5,200 to remove the present equipment and revamp its facilities. This $5,200 is tax deductible at time 0.
Depreciation for tax purposes will be allowed as follows: year 1, $42,000; year 2, $72,000; and in each of years 3 through 5, $32,000
per year. The existing equipment has a book and tax value of $102,000 and a remaining useful life of 10 years. However, the existing
equipment can be sold for only $42,000 and is being depreciated for book and tax purposes using the straight-line method over its
actual life.
Management has provided you with the following comparative manufacturing cost data.
Annual capacity (units)
Annual costs:
Labor
a.
b.
Depreciation
Other (all cash)
Total annual costs
The existing equipment is expected to have a salvage value equal to its removal costs at the end of 10 years. The new equipment is
expected to have a salvage value of $62,000 at the end of 10 years, which will be taxable, and no removal costs. No changes in
working capital are required with the purchase of the new equipment. The sales force does not expect any changes in the volume of
sales over the next 10 years. The company's cost of capital is 16 percent, and its tax rate is 25 percent. Use Exhibit A.8.
C.
Required:
a. Calculate the removal costs of the existing equipment net of tax effects.
b. Compute the depreciation tax shield. (Round PV factors to 3 decimal places.)
c. Compute the forgone tax benefits of the old equipment.
d.
d. Calculate the cash Inflow, net of taxes, from the sale of the new equipment in year 10.
e. Calculate the tax benefit arising from the loss on the old equipment.
1. Compute the annual differential cash flows arising from the investment in years 1 through 10.
g. Compute the net present value of the project.
f.
Present
Equipment
402,000
New
Equipment
402,000
$ 32,500
12,000
50,000
$ 90,000 $ 61,000
Equipment removal net of tax effects
Depreciation tax shield
$ 27,000
16,000
22,000
Forgone tax benefits
Gain from salvage of new equipment
Tax benefit arising from loss on old equipment
Differential cash flows
Net present value
Answer is complete but not entirely correct.
S 3,900
$ 52,500
S 2,550
S 46,5001
$ 15,000
$ 25,125
$ 151,900 X
Transcribed Image Text:Dungan Corporation is evaluating a proposal to purchase a new drill press to replace a less efficient machine presently in use. The cost of the new equipment at time 0, including delivery and Installation, is $205,000. If It is purchased, Dungan will incur costs of $5,200 to remove the present equipment and revamp its facilities. This $5,200 is tax deductible at time 0. Depreciation for tax purposes will be allowed as follows: year 1, $42,000; year 2, $72,000; and in each of years 3 through 5, $32,000 per year. The existing equipment has a book and tax value of $102,000 and a remaining useful life of 10 years. However, the existing equipment can be sold for only $42,000 and is being depreciated for book and tax purposes using the straight-line method over its actual life. Management has provided you with the following comparative manufacturing cost data. Annual capacity (units) Annual costs: Labor a. b. Depreciation Other (all cash) Total annual costs The existing equipment is expected to have a salvage value equal to its removal costs at the end of 10 years. The new equipment is expected to have a salvage value of $62,000 at the end of 10 years, which will be taxable, and no removal costs. No changes in working capital are required with the purchase of the new equipment. The sales force does not expect any changes in the volume of sales over the next 10 years. The company's cost of capital is 16 percent, and its tax rate is 25 percent. Use Exhibit A.8. C. Required: a. Calculate the removal costs of the existing equipment net of tax effects. b. Compute the depreciation tax shield. (Round PV factors to 3 decimal places.) c. Compute the forgone tax benefits of the old equipment. d. d. Calculate the cash Inflow, net of taxes, from the sale of the new equipment in year 10. e. Calculate the tax benefit arising from the loss on the old equipment. 1. Compute the annual differential cash flows arising from the investment in years 1 through 10. g. Compute the net present value of the project. f. Present Equipment 402,000 New Equipment 402,000 $ 32,500 12,000 50,000 $ 90,000 $ 61,000 Equipment removal net of tax effects Depreciation tax shield $ 27,000 16,000 22,000 Forgone tax benefits Gain from salvage of new equipment Tax benefit arising from loss on old equipment Differential cash flows Net present value Answer is complete but not entirely correct. S 3,900 $ 52,500 S 2,550 S 46,5001 $ 15,000 $ 25,125 $ 151,900 X
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