Question

Calculating initial investment Vastine Medical, Inc., is considering replacing its existing computer system, which was purchased 3 years ago at a cost of $325,000. The system can be sold today for $199,000. It is being depreciated using MACRS and a 5-year recovery period (see the table ). A new computer system will cost $495,000 to purchase and install. Replacement of the computer system would not involve any change in net working capital. Assume a 40% tax rate on ordinary income and capital gains. a. Calculate the book value of the existing computer system b. Calculate the after-tax proceeds of its sale for $199,000. 0 Data Table c. Calculate the initial investment associated with the replacement proiec - X a. The remaining book value is $ . (Round to the nearest dollar.) First Four Property Classes Recovery year 3 years 33% 45% 15% 7% Percentage by recovery year 5 years 7 years 20% 14% 32% 25% 19% 18% 12% 12% 10 years 10% 18% 14% 12% SVOUWN 5% 6% 6% Enter your answer in the answer box and then click Check Answer. 4% Totals 100% 100% 100% 100% *These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year parts 2 remaining

Answer 1

Answer (a) - The book value of existing computer system is $94250 as per the calculation mentioned below in excel format(screenshot attached)

Here, EOY = End of the year

Rate = Rate of depreciation as per 5 year recovery period

Dt = Annual Depreciation (calculated by = original cost of the asset * annual rate of 5 year recovery period)

BVt= Book Value at the end of the year (calculated by = Book value at the beginning of the year - Annual Depreciation)

RATE EOY 0 1 20% 32% 19% 12% 12% 5% Dt ($)=(BVt*Rt) BVt ($)=(BVt-Dt) 325000 65000 260000 104000 156000 61750 94250 39000 55250 39000 16250 16250 5

Answer (b) - Capital Gain(in case of a company) arises when any capital asset is used for more than 1 year by a company, for its business purpose and it's sale proceeds is more than the value of the asset during that period.

(i) Capital Gain = Selling Price of computer - Book Value of computer = $199000 - $94250 = $104750

(ii) After Tax Proceeds = Capital Gain - (Capital Gain * 40%) = $104750 - ($104750*40%) = $62850

So, After Tax Proceeds = $62850

Answer (c) - The Initial investment associated with the replacement period = Capital Expenditure +Any change in Working Capital + After tax proceeds from disposed/pld asset

Here, Capital Expenditure = $495000

Change in Working Capital = Nil

After tax proceeds from old asset = $62850

So, Initial Investment = $495000 + 0 +$62850 = $557850