After 8 years of use, the heavy-truck engine-overhaul equipment at Pete’s Truck Repair was evaluated for replacement. Pete’s accountant used an after-tax MARR of 8% per year, Te of 30%, and a current market value of $25,000 to determine AW = $2100. The new equipment costs $75,000, uses SL depreciation over a 10-year recovery period, and has a $15,000 salvage estimate. Estimated CFBT is $15,000 per year. Pete asked his engineer son Ramon to determine if the new equipment should replace what is owned currently. From the accountant, Ramon learned the current equipment cost $20,000 when purchased and reached a zero book value several years ago. Help Ramon answer his father’s question.

Question

What will be an ideal response?

Answer 1

Challenger: Determine AWC and compare it with AWD = $2100.
Defender has DR on trade since BV = 0 now.

DR = SP – BV = 25,000 – 0 = $25,000
Tax on DR = 25,000(0.3) = $7500
Challenger first cost = -75,000 – 7500 = $-82,500
SL depreciation = (75,000 - 15,000)/10 = $6000 per year

CFAT, years 1-10 = CFBT – (CFBT - D)( Te )
= 15,000 – (15,000 – 6000)(0.3)
= $12,300

AWC = -82,500(A/P,8%,10) +15,000(A/F,8%,10) + 12,300
= -82,500(0.14903) + 15,000(0.06903) + 12,300
= $1040

Retain the defender; it has a larger AW value.