Question

1. Sany is thinking of selling an old machine and buying a new, higher capacity machine. It purchased the old machine for $1,000,000 three years ago and depreciated it using simplified straight-line depreciation method. The life of the machine was estimated as 5 years. If Sany can sell the machine for $200,000 today, what is the tax implication from the sale of this old asset? Assume that the tax rate is 40%.

2. You are considering a new project that requires $300,000 investment in a machine, including installation and shipping cost. The life of the machine is three years, and it depreciates via 3-year MACRS methods (33.33%, 44.45%, 14.81%, and 7.41%). If you operate this project, the annual sales of the firm increases by $250,000 a year, and the annual operating expense increased by $100,000. The firm has a marginal tax rate of 34%. In order to start the project, the firm has to invest $30,000 in working capital. The expected market value of the machine is $50,000 in three years when the project is terminated. What is the annual cash flow of this project in the first year?

Round to the nearest penny on both. thanks

Answer 1

Answer 1.

Cost of Machine = $1,000,000
Useful Life = 5 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $1,000,000 / 5
Annual Depreciation = $200,000

Accumulated Depreciation for 3 years = 3 * Annual Depreciation
Accumulated Depreciation for 3 years = 3 * $200,000
Accumulated Depreciation for 3 years = $600,000

Book Value of Machine = Cost of Machine - Accumulated Depreciation for 3 years
Book Value of Machine = $1,000,000 - $600,000
Book Value of Machine = $400,000

Salvage Value = $200,000

Tax on Sale of Machine = (Salvage Value - Book Value) * tax
Tax on Sale of Machine = ($200,000 - $400,000) * 0.40
Tax on Sale of Machine = -$80,000

Answer 2.

Initial Investment = $300,000

Year 1:

Depreciation = 33.33% * $300,000
Depreciation = $99,990

OCF = (Increase in Sales - Increase in Costs) * (1 - tax) + tax * Depreciation
OCF = ($250,000 - $100,000) * (1 - 0.34) + 0.34 * $99,990
OCF = $150,000 * 0.66 + 0.34 * $99,990
OCF = $132,996.60