Discussed from Paperco, Inc. Essay Example for Free

Discussed from Paperco, Inc. EssayThis case study is discussed from Paperco, Inc. vertex of view of whether they should avail the tax benefits and cost savings in replacing the mechanical drying equipment.Recommendation base on the analysis below in this memo, Paperco should purchase novel mechanical drying equipment now in preliminary in anticipation of the passage of recent tax command. Purchasing the equipment now maintains a positive mesh deport Value for the crown project if the legislation is non enacted, or if the refreshful legislation is enacted and the heavy(p) project is contracted early enough so that it is grandfathered in. With tax legislation grandfathered, the project gets the benefit of the brand- clean lower corpo order tax rate and the old ACRS depreciation method. Although when presented with this project one year agone in 1984, Paperco was able to be postponed this capital project since it was merely moderately attractive. The prospect of immat ure tax legislation being enacted as ruto a greater extentd makes the Net Present Value of the project comparatively more positive if the tax police force changes are enacted, so Paperco should act now before tax law changes make this project infeasible.BackgroundIn 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 armed service upstart 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 Papercos management in purchase of new equipment. Paperco felt that the coronation innew equipment as moderately attractive at that time. However, beginning 1986, new tax legislation had been rumored to (1) eliminate the investment tax credit for new equipment (2) extend depreciation lives for new equipment, and (3) reduce the corporate tax rate from 46% to 34%.Papercos senior management was concerned that the basic thrust in the warms sales of mechanical drying equipment. Papercos management suddenly expressed significant interest in moving forward with the purchase of new equipment and seemed anxious to sign a admiting contract.Discussion and synopsisWe need to analyze when is the best situation for Paperco, Inc. to replace the old facilities with new drying equipment that willing enable the bon ton to avail greater tax benefits and cost savings. on that point are three alternative courses of action for sale to Paperco, Inc. to decide whether to buy the new drying equipment or not.I. Buy the new equipment yet no legislation is enactedAdvantages offer to employment a 5 years ACRS depreciation model with higher depreciation expense talent in operations referable to new equipmentDisadvantagesRetain all tax credits due to using 5 year ACRS depreciation model in equipment with useful life of 7 years measure rate continued at 46%II. Buy the new equipment when the new tax proposal is enacted and bind the contract soon enough to be grandfathered or before the enactment of the law AdvantagesContinue to use a 5 years ACRS depreciation model with higher depreciation expense Efficiency in operations due to new equipmentInvestment tax credit that will reduce Papercos taxes revenue rate reduced to 34% from 46%DisadvantagesDepreciation life of the equipment will not be broadIII. Buy the new equipment when the new proposed tax is enacted but do not bind the contract in time to be grandfathered or later on the enactment of the law AdvantagesEfficiency in operations due to new equipmentTax rate reduced to 34% from 46%Depreciation life of the equipment will be extended by 2 yearsDisadvan tagesMACRS depreciation model will generate lower depreciation expenses than the ACRS depreciation model No investment tax credit due to medical dressing the contract after the law was enacted resource I in which the rumored tax proposal is not enacted and that the new equipment replaces the old equipment in December 1986. Paperco would retain all tax credits due to the fact the machine has been in service for 84 months, and use a 5-year ACRS depreciation model for the new equipment. This option has a positive NPV of $2,619,745. choice II in which the new tax proposal is enacted. The new equipment is installed in December 1986. Paperco signs a binding contract soon enough to be grandfathered, this allows Paperco to receive the 8% tax credit and use ACRS depreciation. At the same time, their tax rate would fall to 34%. Paperco would benefit from this more favorable grandfathered tax approach. Option II has a positive NPV of $3,414,104. Option III in which the new tax proposal is ena cted and Paperco installs the new equipment in December 1986, but they do not sign a binding contract in time to be grandfathered and receive the 8% investment tax credit and use ACRS depreciation. The company will use MACRS and a depreciation period of 7 years. The NPV of the project with this timing and structure is $3,228,044. Without the grandfathered tax allowance, the new tax legislation makes the project unattractive based on lower Net Present Value.CalculationsRe-affirmationThere are three options available to Paperco, Inc. with respect to this capital investment Option I New legislation is passed and Paperco qualifies for grandfathering, Option II New legislation is passed and Paperco does not qualify for grandfathering, Option III Buy the new equipment when the new proposed tax is enacted but do not bind the contract in time to be grandfathered or after the enactment of the lawLast year (1984) investment in new drying equipment consistent to Option I was not pursued despi te its attractiveness as a viable capital project, perhaps because it was possible that a better alternative might arise. However, given the impending tax legislation, the possible alternatives are now known, and they are not good. Under the new tax legislation without grandfathering, the project is not viable. Paperco should invest in the new equipment (with binding contract) because not doing so soon enough, the project will not a viable alternative, while investing in the equipment is a viable alternative (i.e., the Net Present Value of the project in Option II is higher than other alternatives).