Calculating initial investment Vanstone Medical Inc., is considering replacing i
ID: 2722129 • Letter: C
Question
Calculating initial investment Vanstone Medical Inc., is considering replacing its existing computer system, which was purchased 3 years ago at a cost of $321,000 The system can be sold today for $207,000. It is being depreciated using MACRS and a 5-year recovery period (see the table). A new computer system will cost $507,000 to purchase and install. Replacement of the computer system would not involve any change in net working capital. Assume a 40% tax rate on ordinary income and capital gains. Calculate the book value of the existing computer system. Calculate the after-tax proceeds of its sale for $207,000. Calculate the initial investment associated with the replacement project The remaining book value is $. (Round to the nearest dollar.) The after-tax proceeds will be $. (Round to the nearest dollar.) The initial investment will be $. (Round to the nearest dollar.)Explanation / Answer
Purchase price of existing computer = $321,000
a.
Depreciation on computer is calculated by using 5 year MACRS rate. According to MARCS rate depreciation rate in first year is 20%, Depreciation rate in second year is 32% and depreciation rate in third year is 19>
So after three year of purchase of existing computer, book value of computer is calculated below using 5 year MACRS depreciation methods:
Book value = $321,000 × (1 – 20%) × (1 – 32%) × (1 – 19%)
= $321,000 × 0.44064
= $141,445.44
Hence, book value of existing computer is $141,445.44.
b.
Book value = $141,445.44
Market value = $207,000
Tax rate = 40%
After tax proceed from sale of existing computer is calculated below:
Proceeds from sale = $207,000 – [($207,000 - $141,445.44) ×40%]
= $207,000 – $26,222
= $180,778
Hence, Proceed from sale of existing computer is $180,778.
c.
Purchase price of new computer = $507,000
Proceed from sale of existing computer = $180,778
Initial Investment in replacement is calculated below:
Initial Investment = $507,000 – $180,778
= $326,222
Hence, initial Investment in replacement is $326,222.
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