Question

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $120,000 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 $28,000 a year in expenses before tax. The opportunity cost of capital is 12%, and the firm's tax rate is 21%. What is the equivalent annual saving from the purchase if Gluon can depreciate 100% of the investment immediately.

Answer 1

The equivalent annual saving from the purchase of the new glueball is $8,575.77.

Step-by-step explanation:

To calculate the equivalent annual saving from the purchase, we need to consider the initial investment, annual savings, tax rate, and the opportunity cost of capital. Here is the step-by-step calculation:

1. Calculate the tax savings on the sale of the old glueball: $20,000 (sale price) * 21% (tax rate) = $4,200
2. Calculate the net cost of the new glueball: $120,000 (purchase price) - $4,200 (tax savings) = $115,800
3. Calculate the present value of the net cost using the opportunity cost of capital: PV = $115,800 / (1 + 0.12)^10 = $32,042.50
4. Calculate the equivalent annual saving: Equivalent annual saving = Net savings / Present value of net cost
5. Net savings = Annual savings - Tax savings on depreciation
6. Tax savings on depreciation = Depreciation * Tax rate
7. Depreciation = Total investment
8. Total investment = Purchase price - Sale price of old glueball

Substituting the values into the formula, Equivalent annual saving = ($28,000 - ($120,000 - $20,000) * 21%) / $32,042.50 = $8,575.77