The Mendoza Company discussed in the chapter is now considering replacing a piece of equipment that the company uses to monitor the integrity of metal pipes used for deep-sea drilling purposes. The companys pre-tax WACC (discount rate) is estimated as 10%. The following data are pertinent to the question youve been asked to analyze:

	Existing Asset	Replacement
Annual (pretax) variable operating expenses	$ 220,000	(?)
Current purchase price	N/A	$ 550,000
Current salvage value of existing asset	$ 44,000	N/A
Current book value of existing asset	$ 66,000	N/A
Expected useful life (years)	6	6
Expected salvage value, end of year 6	$ 11,000	$ 110,000

Part 1 (Algo)

Required:

1. What is the maximum amount of annual variable operating expenses, pretax, that would make this an attractive investment from a present-value standpoint? In answering this question, use the appropriate PV factor(s) from Appendix C, Table 1 and the appropriate PV annuity factor from Appendix C, Table 2. (Round your answer to the nearest whole dollar amount.)

2. Assume now that the company expects, over the coming 6 years, to be subject to a combined income tax rate of 35%, including any gain/loss realized on the sale of the existing equipment. Assume that the current net book value of the existing asset is $66,000 and that the after-tax WACC (discount rate) for Mendoza is 8%. Finally, assume that the company will use straight-line depreciation, with no salvage value, for income tax purposes. In this situation, what is the maximum amount of variable operating costs (on both a pre-tax and on an after-tax basis) that can be incurred in order to make the proposed purchase attractive in a present-value sense? In answering this question, use the appropriate PV annuity factor from Appendix C, Table 2. (Round your answers to the nearest whole dollar amount.)

1.Maximum annual pre-tax variable operating expenses $105,502

2. Maximum annual pre-tax variable operating expenses $109,437

Maximum annual after-tax variable operating expenses $71,134