Davis Inc. is considering buying a new machine for $5 million. This would replace an old...

Davis Inc. is considering buying a new machine for $5 million. This would replace an old machine that they had bought five years ago for $4 million. The old machine was being depreciated using the straight line method and had a 10 year useful life when it was first purchased. They could not sell it at this point since the old machine technology is obsolete. If Davis decides to buy the new machine and replace the old one, what is the change in capital expenditure for the investment? Note this is just asking what is the initial cash flow for this investment, and they are replacing the old machine with a new one. Davis’ tax rate is 25%.

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Expert Solution

Written down value of old machine as per SLM = 4,000,000*5/10 = $2,000,000

Sale value = $0

Loss on Sale = $2,000,000

Tax savings on loss = 2,000,000*25% = $500,000

Hence, capital expenditure for new machine = Purchase cost of new machine - tax savings

= 5,000,000 - 500,000

= $4,500,000

outflow

jeff jeffy answered 2 years ago

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