Problem: Majestic Mining Corporation (MMC) is negotiating the purchase of a new piece of equipment for its current operations. MMC wants to know the maximum price that it should be willing to pay for the equipment. You are given the following facts:
1. The new equipment would replace existing equipment with a current market value of $20,000.
2. The new equipment would not affect revenues, but before-tax operating costs would be reduced by $10,000 per year for eight years. These savings in cost occur at year-end.
3. The old equipment is now five years old. It is expected to last for another eight years, and will have no resale value at that time. It was purchased for $40,000 and is being depreciated to zero by the straight-line method over 10 years.
4. The new equipment will be depreciated to zero by the straight-line method over five years. MMC expects to sell the equipment for $5,000 at the end of eight years. The proceeds from this sale will be subject to taxes at the ordinary corporate income tax rate of 34 percent.
5. MMC has profitable ongoing operations.
6. The appropriate discount rate is 8 percent.