436 REPLACEMENT ANALYSISThis profitable firm pays 40% corporate income
taxes. InJheir economic analysis, they require a 10%
after-tax rate of return. Which of the five alternatives
should the firm adopt?
13-27 MachineAhas been completely overhauled f()r $9000
and is expected to last another 12 years. The $9000
was treated as an expense for tax purposes last
year. Machine Acan be sold now for $30,000 net
after selling expenses, but will have no salvage value
12 years hence. It was bought new 9 years ago
for $54,000 and has been depreciated since then by
straight-line depreciation using a 12-year depreciable
life.
Because less output is now required, Machine
A can now be replaced with a smaller machine:
MachineBcosts $42,000, has an anticipated life of
12 years, and would reduce operating costs $2500 per
year. It would be depreciated by straight-line depre-
ciation with a 12-year depreciable life and no salvage
value.
Both the income tax and capital gains tax rates
are 40%. Compare the after-tax annual cost of the
two machines and decide whether MachineAshould
be retained or replaced by Machine B.Use a 10%
after-tax rate of return in the calculations.13-28 Fred's Rodent Control Corporation has been us-
ing a low-frequency sonar device to locate subter-
ranean pests. This device was purchased 5 years ago
for $18,000. The device has been depreciated using
SOYD depreciation with an 8-year depreciable life
and a salvage value of $3600. Presently, it could be
sold to the cat next door for $7000. If it is kept for the
next 3 years, its market value is expected to drop to
$1600.
A new lightweight subsurface heat-sensing
searcher (SHSS) is available for $10,000 that would
improve the annual net income by $500 for each of
the next 3 years. The SHSS would be depreciated as
a 5-year class property, using MACRS. At the end
of 3 years, the SHSS should have a market value of
$4000. Fred's Rodent Control is a profitable enter-
prise subject to a 40% tax rate.
(a) Construct the after-tax cash flow for the old sonar
unit for the next 3 years.
(b) Construct the after-tax cash flow for the SHSS
unit for the next 3 years.
(c) Construct the after-tax cash flow for the differ-
ence between the SHSS unit and the old sonar
unit for the next 3 years.
l
I(d)Should Fred buy the new SHSS unit if his MARR
is 20%? You do not have to calculate the incre-
mental rate of return; just show how you reach
your decision.13-29 (a) A new employee at CLL Engineering ConSulting
, ,Inc., you are asked to join a team performingan
economic analysis for a client. Your te~ seeltlS
stumped on how to assign an after-tax first cost
to the defender and challenger assets under con-
sideration. Your task is to take the following data
and find the ATCF for each alternative. There is
no need for a complete analysis-your colleagues
can handle that responsibility-they need help
only with the time 0 ATCFs. CLL Inc. has a com-
bined federal/state tax rate of 45% on ordinary
income, depreciation recapture, and losses.Defender:This asset was placed in service
7 years ago. At that time the $50,000 cost ba-
sis was set up on a straight-line depreciation'
schedule with an estimated salvage value of
$15,000 over its lO-year ADR life. This asset
has a present market value of $30,060.Challenger: The new asset being considered
has a first cost of $85,000 and will be depre-
ciated by MACRS depreciation over its lO-year
class life. This asset qualifies for'a 10% invest-
ment tax credit.(b)How would your calculations change if the' ,
present market value of thedefenderis $25,5OO?
(c) How would your calculations change if the
present market value of thedefenderis $18,0001
13-30 Foghorn Leghorn is considering the replacement of
an old egg-sorting machine used with his Foggy's
Farm Fresh Eggs business. The old ,egg machine is
not quite running eggs-actly the way it was originally
designed and will require an additional investment
now of $2500 (expensed at time 0) to get it back
in working shape. This old machine was purchased
6 years ago for $5000 and has been depreciated by
the straight-line method at $500 per year. Six years
ago the estimated salvage value for tax purposes was
$1000. Operating expenses for the old machine are
projected at $600 this next year and are increasing by
$150 per year each year thereafter. Foggy projects that
with refurbishing, machine will last another 3 years.
Foggy believes that he could sell the old machine
as-is today for $1000 to his friend Fido to sort bones.