Depreciation and New Equipment
Point of View
This case study is discussed from Paperco, Inc. point of view of whether they should avail the tax benefits and cost savings in replacing the mechanical drying equipment.
Recommendation
Based on the analysis below in this memo, Paperco should purchase new mechanical drying equipment now in advance in anticipation of the passage of new tax legislation. Purchasing the equipment now maintains a positive Net Present Value for the capital project if the legislation is not enacted, or if the new legislation is enacted and the capital project is contracted early enough so that it is grandfathered in. With tax legislation grandfathered, the project gets the benefit of the new lower corporate tax rate and the old ACRS depreciation method. Although when presented with this project one year ago in 1984, Paperco was able to be postponed this capital project since it was merely “moderately attractive”. The prospect of new tax legislation being enacted as rumored makes the Net Present Value of the project comparatively more positive if the tax law changes are enacted, so Paperco should act now before tax law changes make this project infeasible.
Background
In November 1985, Jane Rogers a marketing representative of Pressco, Inc. approached Paperco, Inc. to sell its mechanical drying equipment at a price of $2.9 million. This new equipment would replace less efficient facilities that had been placed in service late in December 1979. According to Roger, the total cost saving (exclusive of depreciation charges) from the proposed installation of new equipment amounted to $560,000 per year. Of this amount, $360,000 in savings was expected to come from more efficient fuel utilization.
One year earlier, Rogers had been unsuccessful in interesting Paperco’s management in purchase of new equipment. Paperco felt that the investment in new equipment as moderately attractive at that time. However, beginning 1986, new tax legislation had been rumored to: (1)
This case study is discussed from Paperco, Inc. point of view of whether they should avail the tax benefits and cost savings in replacing the mechanical drying equipment.
Recommendation
Based on the analysis below in this memo, Paperco should purchase new mechanical drying equipment now in advance in anticipation of the passage of new tax legislation. Purchasing the equipment now maintains a positive Net Present Value for the capital project if the legislation is not enacted, or if the new legislation is enacted and the capital project is contracted early enough so that it is grandfathered in. With tax legislation grandfathered, the project gets the benefit of the new lower corporate tax rate and the old ACRS depreciation method. Although when presented with this project one year ago in 1984, Paperco was able to be postponed this capital project since it was merely “moderately attractive”. The prospect of new tax legislation being enacted as rumored makes the Net Present Value of the project comparatively more positive if the tax law changes are enacted, so Paperco should act now before tax law changes make this project infeasible.
Background
In November 1985, Jane Rogers a marketing representative of Pressco, Inc. approached Paperco, Inc. to sell its mechanical drying equipment at a price of $2.9 million. This new equipment would replace less efficient facilities that had been placed in service late in December 1979. According to Roger, the total cost saving (exclusive of depreciation charges) from the proposed installation of new equipment amounted to $560,000 per year. Of this amount, $360,000 in savings was expected to come from more efficient fuel utilization.
One year earlier, Rogers had been unsuccessful in interesting Paperco’s management in purchase of new equipment. Paperco felt that the investment in new equipment as moderately attractive at that time. However, beginning 1986, new tax legislation had been rumored to: (1)