In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1, Year 1. The following information is being considered by Gunning Industries. The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000. The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs are comprised of $30 per unit in variable costs and total fixed costs of $40,000 per year. The investment in the new machine will require an immediate increase in working capital of $35,000. Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of five years and zero salvage value. Gunning is subject to a 40 percent corporate income tax rate.
Gunning uses the net present value method to analyze investments and will employ the following factors and rates.
Period
| Present Value of
$1 at 10%
| Present Value of an
Ordinary Annuity of
$1 at 10%
|
|---|
1 | .909 | .909 | 2 | .826 | 1.736 | 3 | .751 | 2.487 | 4 | .683 | 3.170 | 5 | .621 | 3.791 |
Gunning Industries' discounted annual depreciation tax shield for Year 1 would be:
|
a. | $15,200 | |
b. | $16,762 | |
c. | $13,817 | |
d. | $20,725 |
|
