Question

9.40 A machine now in use that was purchased three years ago at a cost of $4,000 has a book value of $2,000. It can be sold now for $2,500, or it could be used for three more years, at the end of which time it would have no salvage value. The annual O&M costs amount to $10,000 for the machine. If the machine is sold, a new machine can be purchased at an invoice price of $14,000 to replace the present equipment. Freight will amount to $800, and the installation cost will be $200. The new machine has an expected service life of five years and will have no salvage value at the end of that time. With the new machine, the expected direct cash savings amount to $8,000 the first year and $7,000 in O&M for each of the next two years. Corporate income taxes are at an annual rate of 40%, and the net capital gain is taxed at the ordinary income-tax rate. The present machine has been depreciated according to a straight-line method, and the proposed machine would be depreciated on a seven-year MACRS schedule. Consider each of the following questions independently:

1. If the old asset is to be sold now, what would be the amount of its equivalent book value?

2. For depreciation purposes, what would be the first cost of the new machine (depreciation base)?

3. If the old machine is to be sold now, what would be the amount of taxable gains and the gains tax?

4. If the old machine is sold for $5,000 now instead of $2,500, what would be the amount of the gains tax?

5. If the old machine had been depreciated by 175% DB and then by a switch to SL depreciation, what would be the current book value?

6. If the old machine were not replaced by the new one and has been depreciated by the 175% DB method, when would be the time to switch from DB to SL depreciation?

Answer 1