You are considering replacing an existing computer system which was purchased 2

Question

You are considering replacing an existing computer system which was purchased 2 years ago at a cost of $325,000. The system can be sold today for $200,000. It is being depreciated using a MACRS 5 year recover period (20%, 32%, 19%, 12%, 12%, and 5%). A new computer system will cost $500,000 including all installation costs. Replacement of the system would not involve any changes in working capital. Assume a 40% tax rate.

        a. Calculate the book value of the old computer system.

        b. Calculate the after-tax proceeds from its sale for $200,000.

        c. Calculate the initial investment associated with the replacement computer.

Explanation / Answer

Total depreciation % in 2 years = 20%+32% = 52%

Total depreciation amount in 2 years = 52%*325,000 = 169,000

a. So book value of old system = 325,000-169,000 = 156,000

b. Profit on sale of system = 200,000-156,000 = 44,000

So after tax proceeds = 200,000 - 44,000*tax rate = 200,000 - 44,000*40% = 182,400

c. Initial investment for replacement computer = cost of new computer + after tax proceeds of old computer sale = 500,000+182,400 = 682,400

Hope this helped ! Let me know in case of any queries.

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