Question

Victoria Energy are considering replacing their existing machinery with new, more efficient equipment. The old machinery was purchased 4 years ago for $15,000,000 and had an estimated useful life of 6 years; it can be sold today for $7,000,000. The new machine will cost $17,500,000 but will have a 10 year life and scrap value at the end of the 10 years of $4,000,000. The new machine will require shipping and installation costs of $300,000 and $100,000 respectively. As the new machine is more efficient, it will also require an increase in net working capital of $5,000,000 today. Victoria Energy depreciates all assets using straight-line method over their useful life and pays tax at the company rate of 30%. The initial investment at t=0 for the incremental decision of selling the old and buying the new machine is (to the nearest dollar):

Select one:

($6,000,000)

($16,100,000)

($17,500,000)

($16,500,000)

($11,500,000)

Answer 1

Computation of Initial Investment amount

S.No	Particulars	Amount
A	Cost of New Machine	$17,500,000
B	Shipping Cost	$300,000
C	Installation Cost	$100,000
D	Total Cost	$17,900,000
E	Proceeds from the Old machine( Refer WN)	$6,400,000.0
F	Increase in Working Capital	$5,000,000
G	Initial Investment( D-E-F)	$16,500,000

* Intial Investment = Equipment Purchase price- Proceeds from sale of Old machine + Increase in Working capital

* Shipping costs and installation cost are to be capitalized.( Any expenses incurred in bringing the asset and installation expenses hasto be capitalized.)

Computation of Proceeds from the old machine( Working Note)

S.No	Particulars	Amount
A	Old Machine Cost	$15,000,000
B	Accumulated Depreciation	$10,000,000
C	Book Value of Machinary	$5,000,000
D	Sale value of Machinary	$7,000,000
E	Gain on sale of Machinary( D-C)	$2,000,000
F	Tax rate @ 30% on E	$600,000.0
G	Proceeds from the sale of Old machine( D-F)	$6,400,000.0

* Depreciation = (Cost of Asset -Scrap value) / Useful life

= ( $ 150,00000-0) /6

= $ 2500000

Accumulated depreciation in 4 years = 4( $ 25,00000)= $ 100,00000

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