Felix Industries purchased a grinder 5 years ago for $15,000. It is being depreciated on a straight-line basis over 15 years to an estimated salvage value of zero. It could be sold now for $6,000. The firm is considering selling it and purchasing a new one. The new grinder would cost $25,000 installed and would be depreciated on a straight-line basis over 10 years to a zero estimated salvage value. The company's marginal tax rate is 40%. Determine the net investment if the old grinder is sold and the new one purchased.

Question

Quizplus · Accepted Answer

Step 1: Calculate the book value (BV) of the old grinder:
- Cost of old grinder = $15,000
- Accumulated Depreciation (15 years) = $15,000/15 x 5 = $5,000
- BV of old grinder = Cost - Accumulated Depreciation = $15,000 - $5,000 = $10,000

Step 2: Calculate the tax effect of selling the old grinder:
- Selling price of old grinder = $6,000
- Taxable gain/loss = Selling price - BV = $6,000 - $10,000 = -$4,000 (loss)
- Tax savings = Marginal tax rate x Taxable loss = 0.4 x (-$4,000) = $1,600

Step 3: Calculate the net investment in the new grinder:
- Cost of new grinder = $25,000
- Tax savings = $1,600 (from step 2)
- Net cost of new grinder = Cost - Tax savings = $25,000 - $1,600 = $23,400

Step 4: Calculate the total net investment:
- Total net investment = Net cost of new grinder - Selling price of old grinder = $23,400 - $6,000 = $17,400

Therefore, the best choice is C) $17,400 as it represents the total net investment required to sell the old grinder and purchase a new one, taking into consideration the tax savings from selling the old grinder.

Felix Industries Purchased a Grinder 5 Years Ago for $15,000