Income Tax Effects Sylvania Manufacturing Company is considering the purchase of new equipment to perform operations currently being performed on less efficient equipment. The purchase price is

$142,000 delivered and installed. A company engineer estimates that the new equipment will save $29,000 in labor and other direct costs annually. The new equipment will have an estimated life of 10 years and zero salvage value at the end of the 10 years. The equipment will be depreciated using a straight-line basis. The existing equipment has a book value of

$4,000, a remaining economic life of five years, and can be disposed of now for $4,000. The company’s average tax rate is 40% (including federal, state, and local taxes), and its after-tax cost of capital is 12%.

Required:

1. Should the new equipment be purchased?

2. What would the decision be if the cost of capital were 10%?

3. Interpretive Question: Assuming that the net present value of an investment in new equipment is so small that you are indifferent about whether to make the purchase or keep the old equipment, what other factors would you consider in making the decision?