Your company is considering replacing an old steel cutting machine with a new on

Question

Your company is considering replacing an old steel cutting machine with a new one. Two months ago, you sent the company engineer to a training seminar demonstrating the new machine’s operation and efficiency. The $2,500 cost for this training session has already been paid. If the new machine is purchased, it would require $5,000 in installation and modification costs to make it suitable for operation in your factory. The old machine originally cost $50,000 five years ago and is being depreciated by $7,000 per year. The new machine will cost $75,000 before installation and modification. It will be depreciated by $5,000 per year. The old machine can be sold today for $10,000. The marginal tax rate for the firm is 40%. Compute the relevant initial outlay in this capital budgeting decision.

Explanation / Answer

Relevant Initial Outlay - Capital Budgeting The Anser is B. $ 68,000 as shown below New Machine Cost $   75,000 Installation and Modification cost $     5,000 Less Old Machine sale value $ -10,000 Tax effect of loss on sale of old machinery $   -2,000 Relevant Initial outlay $   68,000 Working Notes 1. Profit or Loss on sale of Old Machine Original cost $   50,000 Depreciation per annum $     7,000 Number of years in use 5 Accumulated depreciation $   35,000 Net book value $   15,000 Sale Value of old machine $   10,000 Loss on sale of the asset $   -5,000 Tax effet on on loss (40%) $   -2,000 Note:2 Traing cost ($ 2,500) is already incurred and not relavant

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