Question

Initial investment: Basic calculation Cushing Corporation is considering the pur- chase of a new grading machine to replace the existing one. The existing machine was purchased 3 years ago at an installed cost of $20,000; it was being depreciated under MACRS, using a 5-year recovery period. (See Table 4.2 for the applicable depreciation percentages.) The existing machine is expected to have a usable life of at least 5 more years. The new machine costs $35,000 and requires $5,000 in instal- lation costs; it will be depreciated using a 5-year recovery period under MACRS. The existing machine can currently be sold for $25,000 without incurring any removal or cleanup costs. The firm is subject to a 40% tax rate. Calculate the initial investment associated with the proposed purchase of a new grading machine.

Answer 1

Old machiner Cost Depreciation Y1 Depreciation Y2 Depreciation Y3 Net book value 20,000 4,000 6,400 3,800 5,800 Sale price 25,000 10 19,200 7,680 Gain on sale 12 13 14 15 16 17 18 19 20 21 Tax on gain Net sale price 17,320 New machine Cost Installation costs Total cost 35,000 5,000 40,000 23 24 25 26 27 Initial investment on purchase of new machinery and sale of existing machinery Cost of new machinery Net sale price of old machinery Net investment 40,000 17,320 22,680

Old machine Cost Depreciation Y1 Depreciation Y2 Depreciation Y3 Net book value 20000 -СЗ" 20% 4 C3"32% -C3" 1996 -C3-SUM(C4:C6) 7 Sale price 25000 Gain on sale -C9-C7 12 13 14 15 16 17 18 Tax on gain C11*40% Net sale price -C9-C12 New machine Cost Installation costs Total cost 35000 5000 -SUM(C17:C18) 20 21 23 24 25 26 27 Initial investment on purchase of new machinery and sale of existing machinery Cost of new machinery Net sale price of old machinery Net investment -C19 -C14 -C23-C24