Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x48. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The tax effect of selling the new machine in 20x8 would be:
A) $5,000
B) $3,000
C) $2,000
D) $0

Question

Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x48. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The tax effect of selling the new machine in 20x8 would be:
A) $5,000 
B) $3,000 
C) $2,000 
D) $0

Quizplus · Accepted Answer

The tax effect of selling the new machine in 20x8 is zero because the book value of the new machine will be zero at the end of its useful life. This is because the machine will be fully amortized by the end of 20x8. Therefore, there will be no gain or loss on the sale, and no tax effect. The best choice would be to purchase the new machine and dispose of the old machine as it will increase the net income and the cash flows for Bailey Corporation.

Bailey Corporation Is Considering Modernizing Its Production by Purchasing a New