A corporation has decided to replace an exisiting asset with a newer model. Two

Question

A corporation has decided to replace an exisiting asset with a newer model. Two years ago, the existing asset originally cost $30,000 and was being depreciated under MACRS using five-year recovery period. The existing asset can be sold for $25,000. The new asset will cost $75,000 and will also be depreciated under MACRS using a five-year recovery period. If the assumed tax rate is 40 percent on ordinary income and capital gains, the intitial investment is

a. $42,000

b. $54,240

c. $52,440

d. $50,000

Explanation / Answer

Hi,

Please find the answer as follows:

Saleable Value of Old Asset = 25000

Gain/Loss on Sale of Assets = 25000 - 30000*(1-.52) = 10600

Tax on Gain = 10600*.40 = 4240

Total Amount Realized = 25000 - 4240 = 20760

The amount of initial investment would be = 75000 (Cost of New Asset) - 20760 (Saleable Value of Old Asset) = 54240

Option B is correct.

Thanks.

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