ScholarMatic: Explanation & Answer

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The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $90,000.

A new piece of equipment can be purchased for $320,000. It also has an ADR of eight years.

Assume the old and new equipment would provide the following operating gains (or losses) over the next six years:

Ye New Equipment Old Equipment                    Year

1 $80,000 $25,000                                  1

2 76,000 16,000                                    2

3 70,000 9,000                                      3

4 60,000 8,000                                      4

5 50,000 6,000                                      5

6 45,000 (7,000)                                    6

Question: The firm has a 25 percent tax rate and a 9 percent cost of capital. Should the new equipment be purchased to replace the old equipment? Explain your answer.

ScholarMatic: Explanation & Answer

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