Capital Foods purchased an oven 5 years ago for $45,000. The oven is being depreciated over its estimated 10-year life using the straight-line method to a salvage value of $5,000. Capital is planning to replace the oven with a more automated one that will cost $150,000 installed. If the old oven can be sold for $30,000, what is the tax liability? Assume a marginal tax rate of 40 percent.

Question

Quizplus · Accepted Answer

To calculate the tax liability, we need to calculate the gain or loss on the sale of the old oven. The oven was purchased for $45,000 and has been depreciated over 5 years, so the accumulated depreciation is $22,500 ($45,000/10 years x 5 years). The book value of the oven (cost - accumulated depreciation) is $22,500 ($45,000 - $22,500). If the old oven can be sold for $30,000, there is a gain on the sale of $7,500 ($30,000 - $22,500).

The tax liability is equal to the gain on the sale multiplied by the marginal tax rate. In this case, the tax liability is $3,000 ($7,500 x 0.40).

The cost of the new oven is not relevant to the tax liability calculation.

Capital Foods Purchased an Oven 5 Years Ago for $45,000