A corporation has decided to replace an existing asset with a newer model. Two y

Question

A corporation has decided to replace an existing asset with a newer model. Two years ago, the existing asset originally cost $30,000 and was being depreciated under MACRS using a five-year recovery period. The existing asset can be sold for $25,000. The new asset will cost $75,000 and will also be depreciated under MACRS using a five-year recovery period. If the assumed tax rate is 40 percent on ordinary income and capital gains, what is the initial investment? (The 5-year MACRS depreciation rates are 20%, 32%, 19%, 12%, 12%, and 5%.) (5 points) Answer

Explanation / Answer

Purchase price of old equipment = $30,000

Old equipment is 2 year old and depreciation is computed based on MARCS method.

So percentage inflation in first 2 year = 20% + 32%

= 52%.

So,old equipment is 52% depreciated.

So book value of old equipment = $30,000 × (1 - 52%)

= $14,400.

Sale price of old equipment = $25,000

Tax rate = 40%

After tax sale price = $14,400 + ($25,000 - $14,400) × (1 - 40%)

= $14,400 + $6,360

= $20,760

After tax net proceed from sale of old equipment is $20,760.

Purchase price of new equipment = $75,000

Net cost of new equipment = $75,000 - $20,760

= $54,240

Net cost of new equipment is $54,240.

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