Initial investment: Basic calculation Cushing Corporation is considering the pur
ID: 2655066 • Letter: I
Question
Initial investment: Basic calculation 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 120 for the applicable depreciation percentages, whick I included below.) 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
Table 4.2 Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes
Percentage by recovery yeara
Recovery year 3 years 5 years 7 years 10 years
Year 1 - 33%, 20%, 14%. 10%
Year 2 - 45%, 32%, 25%, 18%
Year 3 -15%, 19%, 18%, 14%
Year 4- 7%, 12%, 12%, 12%
Year 5- 12% (5year) 9% (7 years) 9% (10years)
Year 6 - 5% (5year) 9%(7year) 8%(10year)
Year 7 - 9% (7year) 7%(10year)
Year 8 - 4% (7year) 6%(10year)
Year 9 - 6%(10year)
Year 10 - 6%(10year)
Year 11 - 4%(10year)
Totals 100% 100% 100% 100%
aThese 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 depreciation using the half-year convention.
Explanation / Answer
Installed cost of new asset
Cost of new asset
$35,000
Add-Installation Costs
$5,000
Total installed cost (depreciable value) (A)
$40,000
After-tax proceeds from sale of old asset
Proceeds from sale of old asset
$(25,000)
Add-Tax on sale of old asset
$ 7,680
Total after-tax proceeds-old asset (B)
$(17,320)
Initial investment (A-B)
$22,680
Calculation-
Book value of existing machine = $20,000 × (1 (0.20 + 0.32 + 0.19))
$5,800
Recaptured depreciation = $20,000 $5,800 = $14,200
$14,200
Capital gain = $25,000 $20,000 = $5,000
$5,000
Tax on recaptured depreciation = $14,200 × (0.40)
$5,680
Tax on capital gain = $5,000 × (0.40)
$2,000
Total tax
$7,680
Installed cost of new asset
Cost of new asset
$35,000
Add-Installation Costs
$5,000
Total installed cost (depreciable value) (A)
$40,000
After-tax proceeds from sale of old asset
Proceeds from sale of old asset
$(25,000)
Add-Tax on sale of old asset
$ 7,680
Total after-tax proceeds-old asset (B)
$(17,320)
Initial investment (A-B)
$22,680