TPC 07-03 (Static) (LO 7-5, 7-7, 7-8] MG, a corporation in the 21 percent marginal tax bracket, owns equipment that is fully depreciated. This old equipment is still operating and should continue to do so for four years (years 0, 1, 2, and 3). MG's chief financial officer estimates that repair costs for the old equipment will be $1,300 in year 0, $1,400 in year 1, $1,500 in year 2, and $1,600 in year 3. At the end of year 3, the equipment will have no residual value. MG could junk the old equipment and buy new equipment for $5,000 cash. The new equipment will have a three-year MACRS recovery period, should not require any repairs during years 0 through 3, and will have no residual value at the end of year 3. Assume MG cannot make a Section 179 election to expense the $5,000 cost of the new equipment. Use a 10 percent discount rate. Use Table 7-2, Appendix A and Appendix B. Required: a-1. Calculate the NPV of after-tax cost if MG keeps the old equipment. a-2. Calculate the NPV of after-tax cost if MG buys new equipment. a-3. Which option (keep old or buy new) minimizes MG's after-tax cost? b. Assume MG can make a Section 179 election to expense the entire $5,000 cost of the new equipment. Under this change in facts, which option (keep old or buy new) minimizes MG's after-tax cost? Present Value of S1 Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 3% 971 943 915 .888 .863 .837 .813 .789 .766 .744 .722 .701 .681 .661 642 623 .605 587 570 .554 4% 962 925 .889 .855 .822 .790 .760 .731 .703 .676 .650 .625 .601 577 555 .534 513 .494 475 456 5% 952 907 .864 .823 -784 .746 .711 .677 .645 .614 .585 .557 .530 505 481 .458 436 416 396 377 6% 943 .890 .840 .792 .747 .705 .665 .627 .592 558 .527 .497 469 .442 417 394 371 350 331 312 7% 935 .873 .816 .763 .713 .666 .623 582 544 .508 .475 .444 415 388 362 339 317 .296 .277 .258 8% 926 .857 .794 .735 .681 .630 .583 540 500 .463 429 397 368 340 315 .292 .270 -250 .232 .215 9% 917 .842 .772 .708 .650 596 547 .502 460 .422 388 356 326 .299 .275 .252 .231 .212 .194 .178 Periods 1 2 3 4 10% 909 .826 .751 .683 11% 901 .812 .731 .659 12% .893 -797 .712 .636 13% .885 .783 .693 .613 14% .877 .769 .675 592 15% .870 .756 .658 .572 20% .833 .694 579 482 Deductible Repair and Tax Savings Net Cash Present Value at Maintenance at 21% Flow 10% Year 0 $ 1,300 $ 273 $ 1,027 $ 1,300 Year 1 1,400 294 1,106 1,005 Year 2 1,500 1,185 914 Year 3 1,600 336 1,264 949 NPV of after-tax cost $ 4,168 315 Cash Paid on Purchase Recovery Deduction Tax Savings at 21% Net Cash Flow Present Value at 10% Year 0 Year 1 Year 2 Year 3 NPV of after-tax cost 0 Year 3-Year 5-Year 15-Year 20-Year 33.33% 44.45 14.81 7.41 20.00% 32.00 19.20 11.52 11.52 5.76 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Recovery Period 7-Year 10-Year Depreciation Rate 14.29% 10.00% 24.49 18.00 17.49 14.40 12.49 11.52 8.93 9.22 8.92 7.37 8.93 6.55 4.46 6.55 6.56 6.55 3.28 5.00% 9.50 8.55 7.70 6.93 6.23 5.90 5.90 5.91 5.90 5.91 5.90 5.91 5.90 5.91 2.95 3.750% 7.219 6.677 6.177 5.713 5.285 4.888 4.522 4.462 4.461 4.462 4.461 4.462 4.461 4.462 4.461 4.462 4.461 4.462 4.461 2.231
