Question

The Tri-Star Company currently uses an old lathe that was purchased 2 years ago at $6,000. This machine is being depreciation on a MARCS five years (20%, 32%, 19%, 12%, 11%, 6%). The current market value for this machine is $3,000. The proposed new improved lathe cost $10,000 and additional installation fee of $1,000. The new lathe would require that inventories be increased by $800 and account receivable increase $600, but accounts payable would simultaneously increase by $700. Tri-Star's marginal federal-plus-state tax rate is 30%. What is the initial investment of company when evaluating the replacement of old lathe by the new one?

Answer 1

Initial Investment of the company is the amount the company spends on aquiring the new machine.

Cost of New machine = $ 10,000

Additional Installation Fee = $ 1,000

Total Cost = $ 11,000

Additional Working Capital required = Increase in Inventory + Increase in Accounts receivables - Increase in accounts payables.

= 800 + 600 - 700

= $ 700

So, the initial cost of the company when evaluating the replacement of old lathe with the new one is

= 11,000 + 700

= $ 11,700

In the above scenerio it is assumed that the old lathe is not sold as the sale price of old lathe is not given.

** If it is assumed that the machinery is sold at the Market Value of $ 3,000, the initial investment will be:

Purchase price of Old Lathe = $ 6,000

Depreciation in 2 years = Purchase price * (Rate for 1st yr + Rate for 2nd yr)

= 6000 * ( 20% + 32% )

= 6000 * 52%

= $ 3120

Book Value = Purchase price - Depreciation for 2 years

= 6000 - 3120

= $ 2880

Profit on sale at market value = Market Value - Book Value

= 3000 - 2880

= $ 120

Tax on profit = Profit on Sale * tax rate

= 120 * 30%

= $ 36

Initial Investment = Total Cost of new lathe + additional working capial + tax on profit on sale - sale value of old lathe

= 11000 + 700 + 36 - 3000

= $ 8736

Hope I am able to solve your concern. If you are satisfied hit a thumbs up !!