The management of Metro Printers is considering a proposal to replace some existing equipment with a new highly efficient laser printer. The existing equipment has a current book value of $2,200,000 and a remaining life (if not replaced) of 10 years. The laser printer has a cost of $1,300,000 and an expected useful life of 10 years. The laser printer would increase the company’s annual cash flows by reducing operating costs and by increasing the company’s ability to generate revenue. Susan Mills, controller of Metro Printers, has prepared the following estimates of the laser printer’s effect on annual earnings and cash flow:

Don Adams, a director of Metro Printers, makes the following observation: “These estimates look fine, but won’t we take a huge loss in the current year on the sale of our existing equipment? After the invention of the laser printer, I doubt that our old equipment can be sold for much at all.” In response, Mills provides the following information about the expected loss on the sale of the existing equipment:
Book value of existing printing equipment . . . . . . . . . . . . . . . . . . ... $2,200,000
Estimated current sales price, net of removal costs . . . . . . . . . . . ..... 200,000
Estimated loss on sale, before income taxes . . . . . . . . . . . . . . . .... $2,000,000
Reduction in current year’s income taxes as a result of loss (40%)..... 800,000
Loss on sale of existing equipment, net of tax savings . . . . . . . . .... $1,200,000
Adams replies, “Good grief, our loss would be almost as great as the cost of the laser itself. Add this $1,200,000 loss to the $1,300,000 cost of the laser, and we’re into this new equipment for $2,500,000. I’d go along with a cost of $1,300,000, but $2,500,000 is out of the question.”

Instructions
a. Use Exhibits 26–3 and 26–4 to help compute the net present value of the proposal to sell the existing equipment and buy the laser printer, discounted at an annual rate of 15 percent.
In Exhibits 26–3

In Exhibits 26–4

In your computation, make the following assumptions regarding the timing of cash flows:
1. The purchase price of the laser printer will be paid in cash immediately.
2. The $200,000 sales price of the existing equipment will be received in cash immediately.
3. The income tax benefit from selling the equipment will be realized one year from today.
4. Metro uses straight-line depreciation in its income tax returns as well as its financial statements.
5. The annual net cash flows may be regarded as received at year-end for each of the next 10 years.
b. Is the cost to Metro Printers of acquiring the laser printer $2,500,000, as Adams suggests?
Explainfully.

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Estimated increase in annual cash flows (before taxes) Cost savings (other than depreciation) Reduction in annual depreciation expense . . . 110,000 $250,000 Estimated increase in income before income taxes. .. . . .. . . . $340,000 Increase in annual income taxes (40%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136,000 Estimated increase in annual net income . . .. . . . . . . $204,000 Estimated increase in annual net cash flows Present Value of $1 Due in n Periods* Number of Periods Discount Rate 1% 1 % 5% 990 .985 980 971 971 956 961942 951.928 942 915 933 901 923 888 914 875 905 862 820742 788 700 699 6% 8% 10% 12% 15% 20% 952 943926 99 893 870 833 907 890 87 82797756 694 864840 794 751 712 658 579 823 792 735 683 636 572 482 784 74768 621 567 497 402 746 705 630 564 507 432 35 711 665 583 513 452376 279 677 627 540 47404327 233 645 592 500 424284 194 614 558 463 386 322 47162 377 312 215 49 104061 026 310 2478 102 066 035 013 173 123 063 032 017 007 001 2 3 4 6 7 10 20 24 36 585 Present Value of S1 to Be Received Periodically for n Periods Number of Periods Discount Rate 1% 1,2% 8% 10% 12% 15% 20% 0.990 0.985 0.952 0.943 0.926 0.909 0.893 0.870 0.833 1.970 956 .859 1.833 1.783 1.736 1.690 1.626 1.528 2.941 2.912 2.723 2.673 2.577 2.487 2.402 2.283 2.106 3.902 3.854 3.546 3.465 3.312 3.170 3.037 2.855 2.589 4.853 4.783 4.329 4.212 3.993 3.791 3.605 3.352 2.991 5.795 5.697 5.076 4.917 4.623 4.355 4.111 3.784 3.326 6.728 6.598 5.786 5.582 5.206 4.868 4.564 4.160 3.605 7.652 7.486 6.463 6.210 5.747 5.335 4.968 4.487 3.837 8.566 8.361 7.108 6.802 6.247 5.759 5.328 4.772 4.031 9.471 9.222 7.722 7.360 6.710 6.145 5.650 5.019 4.192 18.046 17.169 12.462 11.470 9.818 8.514 7.469 6.259 4.870 21.243 20.030 13.799 12.550 10.529 8.985 7.784 6.434 4.937 30.108 27.661 16.547 14.621 11.717 9.677 8.192 6.623 4.993 5% 2 3 4 10 20 24 36