Cushing Corporation is considering the purchase of a new grading machine to repl

Question

Cushing Corporation is considering the purchase of a new grading machine to replace the existing one. The existing machine was purchased 3 years ago at an installed cost of $20,000; it was being depreciated under MACRS using a 5-year recovery period. (See Table 4.2 on page 117 for the
applicable depreciation percentages.) The existing machine is expected to have a usable life of at least 5 more years. The new machine costs $35,000 and requires $5,000 in installation costs; it will be depreciated using a 5-year recovery period under MACRS. The existing machine can currently be sold for $25,000 without incurring any removal or cleanup costs. The firm is subject to a 40% tax rate. Calculate the initial investment associated with the proposed purchase of a new grading machine.

Explanation / Answer

Installed cost of new Machne =35,000 + 5,000 = $40,000 ....(A) Book value of existing machine =$20,000 – (20%+32%+19.20%)*$20000 = $5,760 From the sale of the existing machine, we would have: Recovered depreciation = 20,000 – 5,760 = $14,240 Capital gain = 25,000 – 20,000 = $5,000 Tax on recovered depreciation = $14,240 * 40% = $5,696 Tax on capital gain = 5,000 * 40% = 2,000 Total tax on sale of existing machine= $5696+ $2,000= $7696 So After-tax proceeds from sale of existing Machne = 25,000 - 7696 = $17,304 So Initial Investment = A - $17,304 is Initial Inv = 40,000 – $17,304 = $22,696

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