1. A company is considering whether to buy a regular or color photocopier for their office. The cost of the regular photocopy machine is $12,000, its life span is 5 years, and the company has to pay another $1,500 annually in maintenance costs. The color photocopiers price is $20,000, its life span is also 5 years, and the annual maintenance costs are $4,500. Compared to the regular photocopier, the color photocopier is expected to increase the revenue of the office by $10,000 annually before taxes. Both photocopiers fall into the MACRS 3-year property class and the applicable depreciation rates are 33%, 45%, 15%, and 7% respectively for years 1, 2, 3, and 4. However, the market values of the photocopiers at the end of their 5-year life are expected to be $2,000 (regular) and $10,000 (color). Assume that the company is profitable and pays a 21% tax rate. The appropriate discount rate for the projects is 12%. Which photocopy machine should the firm buy?

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K 1 BUYING A PHOTOCOPIER Annual Annual Life (years) maintenance revenue costs increase 5 5 Selling price in 5 years Discount rate Purchase price today 12,000 20,000 Tax rate 1 33% 2 45% 3 15% 4 7% 0 1 2 3 4 5 2 3 Regular photocopier 4 Color photocopier 5 8 Year 7 MACRS depreciation rates 8 9 10 Regular photocopier cash flows 11 Year 12 Purchase price 13 Incremental revenue 14 Less: Maintenance cost 15 Less: Depreciation 18 Earnings before tax (EBT) 17 Less: Taxes 18 Net Income after tax 19 Add: Depreciation back 20 Add: Terminal cash flow (after tax) 21 Annual cash flows (after tax) 22 NPV 23 24 Color photocopier cash flows 25 Year Purchase price 26 27 Incremental revenue 28 Less: Maintenance cost 29 Less: Depreciation 30 Earnings before tax (EBT) 31 Less: Taxes 32 Net income after tax 33 Add: Depreciation back 34 Add: Terminal cash flow (after tax) 35 Annual cash flows (after tax) 36 NPV 37 38 Decision: 0 2 3 4 5 Calculating terminal cash flows of the coplers at the end of year 5 Regular copler Color copier Book value at the end of year 5) Selling price at the end of year 5) Capital gains (or loss) Taxes on capital gains (losses) Terminal cash flow after tax) K 1 BUYING A PHOTOCOPIER Annual Annual Life (years) maintenance revenue costs increase 5 5 Selling price in 5 years Discount rate Purchase price today 12,000 20,000 Tax rate 1 33% 2 45% 3 15% 4 7% 0 1 2 3 4 5 2 3 Regular photocopier 4 Color photocopier 5 8 Year 7 MACRS depreciation rates 8 9 10 Regular photocopier cash flows 11 Year 12 Purchase price 13 Incremental revenue 14 Less: Maintenance cost 15 Less: Depreciation 18 Earnings before tax (EBT) 17 Less: Taxes 18 Net Income after tax 19 Add: Depreciation back 20 Add: Terminal cash flow (after tax) 21 Annual cash flows (after tax) 22 NPV 23 24 Color photocopier cash flows 25 Year Purchase price 26 27 Incremental revenue 28 Less: Maintenance cost 29 Less: Depreciation 30 Earnings before tax (EBT) 31 Less: Taxes 32 Net income after tax 33 Add: Depreciation back 34 Add: Terminal cash flow (after tax) 35 Annual cash flows (after tax) 36 NPV 37 38 Decision: 0 2 3 4 5 Calculating terminal cash flows of the coplers at the end of year 5 Regular copler Color copier Book value at the end of year 5) Selling price at the end of year 5) Capital gains (or loss) Taxes on capital gains (losses) Terminal cash flow after tax)