Question

As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold taday for 75,500. Its operating costs are $23,400 a year, but in five years the machine will require a $18,300 overhaul. Thereafter operating costs will be $31,700 until the machine is finally sold in year 10 for $7,550. The older machine could be sold today for $26,700. If it is kept, t will need an immediate $28,500 overhaul. Thereafter operating costs will be $36,000 a year until the machine is finally sold in year 5 for $7,550 Both machines are fully depreciated for tax purposes. The mpany pays tax at 35%. Cash flows have been forecasted in real terms. The real cost of capital is 9%, a. Calculate the equivalent annual costs for selling the new machine and for selling the old machine. (Do not round intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.) Equivalent Annual Cost ell new machine Sell old machin

Answer 1

Since in this question, details relating to investment in machines (cost of machines) is not given, we would solve the question concentrating on the annual operating expenses and overhauling costs. The given rate of tax is 35% and discount rate is 9%.

It is also given that both the machines are depreciated in full for tax purposes. Hence, the entire overhauling cost is depreciated on straight line basis over the remaining life of the machines without considering salvage value for the purpose of depreciation. In case of new machine, since overhauling is incurred after the period of 5 years, depreciation is calculated for remaining 5 years of life.

The present value discount rates are arrived by referring to annuity tables @ 9% rate for n^th year. The annuity values are arrived by referring to annuity table @ 9% rate for 'n' years.

The annual operating expenses are considered net of taxes as there is savings in cash flow to the extent of taxes on it. Similarly, tax savings on depreciation is deducted from the expenses as there savings in cash outflow to the extent of taxes on depreciation. Salvage value is also taken net of taxes since it forms part of income because the machine is fully depreciated. The company needs to pay tax @35% on cash inflow on sale of machines i.e., need to pay tax @ 35% on salvage inflows.