The Trimark Corporation is considering replacing an existing machine that cost $125,000 three years ago with one that will cost $200,000 today. The existing machine is being depreciated for
Tax purposes over 5 years using straight-line depreciation. The new machine would be
Depreciated over 5 years using straight-line depreciation as well. Trimark pays taxes at a
Marginal rate of 40%. If Trimark buys the new machine, what will be the annual tax savings
From the incremental depreciation for each of the first five years?

Question

Quizplus · Accepted Answer

To calculate the incremental depreciation, we first need to calculate the remaining book value of the existing machine, which is the cost of the machine minus the accumulated depreciation.

The existing machine was purchased 3 years ago and is being depreciated over 5 years with straight-line depreciation. Therefore, each year the machine is depreciated by $125,000/5 = $25,000.

After 3 years, the accumulated depreciation is $25,000/year x 3 years = $75,000. Therefore, the remaining book value of the machine is $125,000 - $75,000 = $50,000.

The new machine will cost $200,000 and will be depreciated over 5 years with straight-line depreciation. Therefore, the annual depreciation expense will be $200,000/5 = $40,000.

The incremental depreciation is the difference between the annual depreciation of the new machine and the remaining annual depreciation of the old machine.

In the first two years, the old machine would have been depreciated by $25,000/year, so the incremental depreciation would be $40,000 - $25,000 = $15,000.

In the last three years, the old machine would have been fully depreciated, so the incremental depreciation would be $40,000 - $0 = $40,000.

Therefore, the annual tax savings from the incremental depreciation for each of the first five years would be:

- Year 1 and 2: $15,000
- Year 3 to 5: $40,000

The best choice is B, as it correctly calculates the incremental depreciation for each year. To calculate the annual tax savings from the incremental depreciation, we first need to determine the depreciation expense for each machine for the next five years.

For the existing machine:
Depreciation per year = Cost of machine / number of years
Depreciation per year = $125,000 / 5
Depreciation per year = $25,000

For the new machine:
Depreciation per year = Cost of machine / number of years
Depreciation per year = $200,000 / 5
Depreciation per year = $40,000

So, the incremental depreciation per year = Depreciation expense of new machine - Depreciation expense of existing machine
Incremental depreciation per year = $40,000 - $25,000
Incremental depreciation per year = $15,000

To calculate the tax savings, we need to multiply the incremental depreciation by the marginal tax rate of 40%.
Tax savings = Incremental depreciation per year x Marginal tax rate
Tax savings = $15,000 x 0.4
Tax savings = $6,000

Therefore, the annual tax savings from the incremental depreciation for the first two years will be $6,000 and for the last three years will be $16,000. Hence, the answer is B.

The Trimark Corporation Is Considering Replacing an Existing Machine That