Capital Buget ACCT615

Marker’s Tattoo Studio wants to buy new laser therapy equipment. This new equipment would cost $300,000 to purchase and $20,000 to install. Marker’s estimates that this new equipment would yield incremental margins of $98,000 annually due to new client services. It would require incremental cash maintenance costs of $10,000 annually. Marker’s expects the life of this equipment to be 5 years. They estimate a terminal disposal value of $20,000.

Marker’s has a 25% income tax rate and depreciates assets on a straight-line basis (to terminal value) for tax purposes. The required rate of return on investments is 10%.

• Determine the expected increase in annual net income from investing in the new equipment.
• Calculate the accrual accounting rate of return based on average investment.

Summarize whether the new equipment is worth investing in from a net present value (NPV) standpoint.

Suppose that the tax authorities are willing to let Marker’s depreciate the new equipment down to zero over its useful life. If Marker’s plans to liquidate the equipment in 5 years, should it take this option? Quantify the impact of this choice on the NPV of the new equipment.