P11-12 (similar to) Initial investmentlong dash—Basic calculationCushing Corpora
ID: 2794718 • Letter: P
Question
P11-12 (similar to)
Initial
investmentlong dash—Basic
calculationCushing Corporation is considering the purchase of a new grading machine to replace the existing one. The existing machine was purchased
4
years ago at an installed cost of
$19,900;
it was being depreciated under MACRS using a 5-year recovery period. (See table
LOADING...
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
$35,200
and requires
$4,800
in installation costs; it will be depreciated using a 5-year recovery period under MACRS. The existing machine can currently be sold for
$24,600
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.
The initial investment will be
$nothing .
(Round to the nearest dollar.)
Rounded Depreciation Percentages by Recovery Year Using MACRS for
First Four Property Classes
Percentage by recovery year*
Recovery year
3 years
5 years
7 years
10 years
1
33%
20%
14%
10%
2
45%
32%
25%
18%
3
15%
19%
18%
14%
4
7%
12%
12%
12%
5
12%
9%
9%
6
5%
9%
8%
7
9%
7%
8
4%
6%
9
6%
10
6%
11
4%
Totals
100%
100%
100%
100%
*These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year convention.
Rounded Depreciation Percentages by Recovery Year Using MACRS for
First Four Property Classes
Copy to Clipboard + Open in Excel +Percentage by recovery year*
Recovery year
3 years
5 years
7 years
10 years
1
33%
20%
14%
10%
2
45%
32%
25%
18%
3
15%
19%
18%
14%
4
7%
12%
12%
12%
5
12%
9%
9%
6
5%
9%
8%
7
9%
7%
8
4%
6%
9
6%
10
6%
11
4%
Totals
100%
100%
100%
100%
*These percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance (200%) depreciation using the half-year convention.
Explanation / Answer
Installed cost of new asset =35,200 + 4,800 = $40,000 (depreciable value)
Book value of existing machine =$19,900 – (19,900×4)/5
= $3,980
From the sale of the existing machine, we would have:
Recovered depreciation= 19,900 – 3,980=$15,920
Capital gain= 24,600 – 19,900=$4,700
Tax on recovered depreciation = $15,920 × (0.40) = 6,368
Tax on capital gain = 4,700 × (0.40) = 1,880
Total tax on sale of existing machine= 6,368 + 1,880= $8,248
Hence:
After-tax proceeds from sale of old asset == 24,600 – 8,248 = $16,352
Initial Investment =40,000 – 16,352 = $23,648
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