Question

Initial investment at various sale prices Edwards Manufacturing Company (EMC) is

considering replacing one machine with another. The old machine was purchased 3

years ago for an installed cost of $10,000. The firm is depreciating the machine under

MACRS, using a 5-year recovery period. (See Table 4.2 on page 120 for the applicable

depreciation percentages.) The new machine costs $24,000 and requires

$2,000 in installation costs. The firm is subject to a 40% tax rate. In each of the following

cases, calculate the initial investment for the replacement.

a. EMC sells the old machine for $11,000.

b. EMC sells the old machine for $7,000.

c. EMC sells the old machine for $2,900.

d. EMC sells the old machine for $1,500.

Answer 1

The Depreciation for the old machine under MACRS for 3 Years is calculated below:
Year	Deprecition rate [%]	Depreciation
1	20.0	2000
2	32.0	3200
3	19.2	1920
		7120
The Book value of old machine = 10000-7120 = $2,880.
Option	Replacement cost including installation	Sale value of the old machine	Book value of old machine	Gain/(Loss) on sale of old machine	Tax on gain/(Tax shield on loss) at 40%	Net after tax sale value of old machine	Net initial investment for replacement
[1]	[2]	[3]	[4]	[5]	[6]	[7]	[8]
a	$              26,000	$            11,000	$              2,880	$            8,120	$           3,248	$           4,872	$         21,128
b	$              26,000	$              7,000	$              2,880	$            4,120	$           1,648	$           2,472	$         23,528
c	$              26,000	$              2,900	$              2,880	$                  20	$                   8	$                 12	$         25,988
d	$              26,000	$              1,500	$              2,880	$          (1,380)	$            (552)	$            (828)	$         26,828
NOTE:
Col 5 = Col 3 - Col 4
Col 6 = Col 5*40%
Col 7 = Col 5 - Col 6
Col 8 = Col 2 - Col 7
Col 8 gives the answers for questions a,b,c,d.