REPLACEMENT PROBLEM WITH MACRS
Bradley Corp. purchased a computer two years ago for $120,000. The asset is
being depreciated under the five-year MACRS schedule. The old computer can be
sold for $37,600. A new computer will cost $180,000 and will also be written off
using the five-year MACRS schedule.
The new computer will provide cost savings and operating benefits over the old
computer of $42,000 per year for the next 6 years. The firm has a 35 percent
tax rate and a 10 percent cost of capital. Should Bradley Corp. replace its
computer? Use NPV method.
NET COST
Year
Percentage
Depreciation Depreciation Annual
Base
(see MACRS) Depreciation
1..
2..
$120,000
120,000
.200
.320
$24,000
38,400
Total depreciation to date
$62,400
Purchase price
$120,000
Total depreciation to date
62,400
Book value
$ 57,600
Book value $57,600
Sales price
37,600
Tax loss on sale$20,000
Tax loss on sale$20,000
Tax rate
35%
Tax benefit $ 7,000
Sale price of old computer$37,600
Tax benefit from sale
$ 7,000
Cash inflow from sale of old computer $44,600
Price of new computer
$180,000
- Cash flow from sale of old computer 44,600
Net cost of new computer$135,400
NET BENEFIT
The annual depreciation on the new computer will be:
YearDepreciation Percentage
Annual
.............. Base
DepreciationDepreciation
1
2
3
4
5
6
$180,000
180,000
180,000
180,000
180,000
180,000
.200$36,000
.320 57,600
.192 34,560
.115 20,700
.115 20,700
.058 10,440
$180,000
The annual depreciation on the old computer for the remaining four years
would be:
Year
1.
2
3
4
Dep. Base
$120,000
120,000
120,000
120,000
Percentage Annual
Depreciation
Depreciation
.192 $23,040
.115 13,800
.115 13,800
.058
6,960
Note:: The next four years represent the last four years for the old computer,
which is already two years old.
'
Calculate the tax shield benefit of the incremental depreciation:
(2)
(3)
(4) (5)
(1) Depreciation on Depreciation onIncremental
Year Now ComputerOld ComputerDepreciationRate
1
2
3
4
$36,000
57,600
34,560
20,700
$23,040
13,800
13,800
6,960
$12,960
43,800
20,760
13,740
(6)
Tax
Benefit
.35 $ 4,536
.35 15,330
.35
7,266
.35
4,809
Tax Shield
5
6
20,700
10,440
20,700
10,440
.35
.35
7,245
3,654
Calculate the aftertax cost savings:
(1)
(2)
Year Cost Savings
1
2
3
4
5
6
$42,000
42,000
42,000
42,000
42,000
42,000
(3)
(4)
Aftertax
I - Tax Rate
Savings
.65
.65
.65
.65
.65
.65
$27,300
27,300
27,300
27,300
27,300
27,300
PRESENT VALUE OF BENEFITS
(1)
(2)
(3)
Tax Shield Benefits Aftartax Cost
from Depreciation
Savings
Year
1
2
3
4
5
6
$ 4,536
15,330
7,266
4,809
7,245
3,654
(4)
(5)
total
AnnualPresent Value
Benefits Factor (10%)
$27,300 $31,836
27,300 42,630
27,300 34,566
27,300. 32,109
27,300 34,545
27,300 30,954
(6)
Present
Value
.909$28,939
.82635,212.
.75125,959
.68321,930.
.62121,452
.56417,458
Present value of incremental benefits
Present value of incremental benefits
Net cost of new computer
NPV
$150,950
135,400
$ 15,550
Therefore, Bradley Corp. should accept the project.
$150,950