Question

Five years ago, your company purchased a machine used in manufacturing for $110,000. You have learned that a new machine is available that offers many advantages; you can purchase it for $150,000 today. It will be depreciated on a straight-line basis over ten years and has no salvage value.

You expect that the new machine will reduce the current investment in working capital by $10,000.

The current machine is being depreciated on a straight-line basis over a useful life of 11 years and has no salvage value. The current market value of the old machine is $50,000 Your company’s tax rate is 45%, and the opportunity cost of capital for this type of equipment is 10%.

Required:

1. Tax loss or gain on the selling the old plant. (2 Points)
2. The initial cash flow on the new plant. (3 points)
3. Incremental depreciation expenses which can be claimed for the taxes (1 Points)

Answer 1

1. Computation of tax gain or loss on sale of old plant

Particulars	Amount
A. Cost of machine five year ago	$110,000
B. Less(-) Accumulated depreciation for 5 year (110,000/11*5)	($50,000)
C. Written down value( current book value) [A-B]	$60,000
D. Less(-) currant market value/sale value of old machine	$50,000
E. Capital gain on selling of old machine [C-D]	$10,000
F. Tax gain on capital loss $10,000*45%	$4500

2. The initial cash flow on the new plant.

Particulars	Amount
A. Cost of new machine	$150,000
B. Less(-) Sale of old machine	($ 50,000)
C.Less(-) reduction in working capital	($10,000)
D. Add(+)Capital gain tax on sae of old machine ($10,000*45%)	$4,500
E. Add(+) Loss of opportunity cost [$150,000(new)-$50,000(old)-$10,000(wc)]*10%	$9000
F. Net Cash Flow [A-B-C+D+E)	$103,500

note: opportunity cost assume interest income on additional fund  

3.Incremental depreciation expenses which can be claimed for the taxes

Particulars	Amount
A. Depreciatin on new machine (150,000/10)	$15,000
B. Less(-) Depreciation on old machine ($110,000/11)	($10,000)
C. Incremantal Depreciation [A-B]	$5000