XYZ company is considering replacing an old machine with a new one.Two months ago their chief engineer completed a training seminar on the new machine's operation and efficiency.The $3,000 cost for this training session has already been paid.If the new machine is purchased,it would require $7,000 in installation and modification costs to make it suitable for operation in the factory.The old machine originally cost $80,000 five years ago and is being depreciated by $10,000 per year.The new machine will cost $100,000 before installation and modification.It will be depreciated by $12,000 per year.The old machine can be sold today for $12,000.The marginal tax rate for the firm is 40%.Compute the relevant initial outlay in this capital budgeting decision.

Question

Quizplus · Accepted Answer

The initial outlay can be calculated as follows:

Sale of old machine = $12,000
Cost of new machine = $100,000
Installation and modification costs = $7,000
Total cost of new machine = $107,000
Depreciation on old machine = $10,000 x 5 = $50,000
Depreciation on new machine = $12,000 x 1 = $12,000
Tax savings due to depreciation = ($12,000 + $10,000) x 40% = $8,800
Net cost of new machine (after tax savings) = $107,000 - $8,800 = $98,200
Total initial outlay = $98,200 - $12,000 - $3,000 = $83,200

Therefore, the best choice is D, with an initial outlay of $87,800 (cost of new machine + installation and modification costs - sale of old machine - tax savings due to depreciation - cost of training session).

XYZ Company Is Considering Replacing an Old Machine with a New