A firm is trying to determine whether to replace an existing asset. The proposed

Question

           A firm is trying to determine whether to replace an existing asset. The proposed asset has a purchase price of $50,000 and has installation costs of $3,000. The asset will be depreciated over its five year life using the straight-line method. The new asset is expected to increase sales by $17,000 and non-depreciation expenses by $2,000 annually over the life of the asset. Due to the increase in sales, the firm expects an increase in working capital during the asset's life of $1,500, and the firm expects to be able to sell the asset for $6,000 at the end of its life. The existing asset was originally purchased three years ago for $25,000, has a remaining life of five years, and is being depreciated using the straight-line method. The expected salvage value at the end of the asset's life (i.e., five years from now) is $5,000; however, the current sale price of the existing asset is $20,000, and its current book value is $15,625. The firm's marginal tax rate is 34 percent and its required rate of return is 12 percent.   If the new machine is purchased, depreciation expense will increase or   decrease by:             increase $8,000
       increase $6,900
       Increase $6,300
       decrease $5,000

Explanation / Answer

Hi,

Please find the answer as follows:

Depreciation Per Year on Old Machine = (25000 - 5000)/8 = 2500

Depreciation Per Year on New Machine = =(50000+3000-6000)/5 = 9400

Increase in Depreciation = 9400 - 2500 = 6900

Answer is Increase by 6900

Thanks.

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