Disquotek, Inc., is a software manufacturer. Managers are considering a new equipment proposal. The income tax rate is 40%, and the discount rate is 10%. The following data are available: Old Equipment New Equipment
Purchase cost $12,000 $36,000
Annual amortization 1,500 4,500
Remaining useful life (years)8 8
Current selling price 14,400 not applicable
Selling price in 8 years 1,000 2,000
Annual operating costs 14,000 8,000
What is the relevant after-tax annual cash operating cost associated with this decision?

Question

Quizplus · Accepted Answer

To calculate the relevant after-tax annual cash operating cost, we need to take into account the depreciation tax shield on the new equipment and the annual operating costs for both options.

For the old equipment, the depreciation tax shield is ($12,000 / 8) x 0.4 = $600 per year.

For the new equipment, the depreciation tax shield is ($36,000 / 8) x 0.4 = $1,800 per year.

The after-tax annual cash operating cost for the old equipment is $14,000 - $600 = $13,400.

The after-tax annual cash operating cost for the new equipment is $8,000 - $1,800 = $6,200.

Therefore, the relevant after-tax annual cash operating cost associated with this decision is $6,200 - $13,400 = -$7,200. This means that the new equipment is actually cheaper to operate than the old equipment and generates a positive cash flow of $7,200 per year.

The best choice is to choose the new equipment because it generates a positive cash flow and is cheaper to operate in the long run.