Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $110,000 and sell its old low-pressure glueball, which is fully depreciated, for $20,000. The new equipment has a 10-year useful life and will save $24,000 a year in expenses. The opportunity cost of capital is 10%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value.
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To calculate the equivalent annual savings, we need to find the depreciation expense for the new machine using straight-line depreciation method.
First, we calculate the depreciation expense per year:
Depreciation Expense = (Purchase Cost - Salvage Value) / Useful Life
Since the new machine has no salvage value, the Depreciation Expense per year is:
Depreciation Expense = $110,000 / 10 years = $11,000 per year
Next, we need to calculate the tax savings from depreciation:
Tax Savings from Depreciation = Depreciation Expense * Tax Rate
Tax Savings from Depreciation = $11,000 * 0.40 = $4,400 per year
Now, we can calculate the equivalent annual savings:
Equivalent Annual Savings = Net Annual Cash Flow after Tax
Net Annual Cash Flow after Tax = Annual Expense Savings + Tax Savings from Depreciation
Annual Expense Savings = Expense Savings per year - Depreciation Expense per year
Annual Expense Savings = $24,000 - $11,000 = $13,000 per year
Therefore, the Net Annual Cash Flow after Tax is:
Net Annual Cash Flow after Tax = $13,000 + $4,400 = $17,400 per year
Hence, the equivalent annual savings from the purchase of the new glueball using straight-line depreciation is $17,400 per year.
To determine the equivalent annual savings from the purchase of the new high pressure glueball, we need to calculate the annual savings and depreciation expense.
First, let's determine the annual savings:
Annual savings = Savings per year - Salvage value of old equipment
Savings per year = $24,000 (as given in the question)
Salvage value of old equipment = $20,000 (as given in the question)
Therefore, the annual savings = $24,000 - $20,000 = $4,000.
Next, let's calculate the annual depreciation expense:
Depreciation expense = (Cost of new equipment - Salvage value) / Useful life
Cost of new equipment = $110,000 (as given in the question)
Salvage value = $0 (since the new machine will have no salvage value)
Useful life = 10 years (as given in the question)
Depreciation expense = ($110,000 - $0) / 10 = $11,000 per year.
Now, we can calculate the tax shield, which is the tax savings due to depreciation:
Tax shield = Depreciation expense * Tax rate
Tax rate = 40% (as given in the question)
Tax shield = $11,000 * 0.40 = $4,400.
Finally, we can calculate the equivalent annual savings:
Equivalent annual savings = Annual savings + Tax shield
Equivalent annual savings = $4,000 + $4,400 = $8,400.
Therefore, the equivalent annual savings from the purchase of the new high pressure glueball, using straight-line depreciation, is $8,400.