The following data is associated with a proposed replacement project: A machine that originally cost $25,000 and was depreciated on a straight line basis has one year of its expected 5-year life remaining. Its current market value is $12,000. The corporate tax rate is 34%. The cash flow from disposing of the old machine, is:
A)$12,000.
B)$ 9,620.
C)($ 9,620.)
D)$14,380.

Question

Quizplus · Accepted Answer

The cash flow from disposing of the old machine is calculated as the difference between the market value and the tax adjusted book value. The tax adjusted book value is equal to the original cost minus accumulated depreciation minus any tax savings from the depreciation. The accumulated depreciation is equal to ($25,000 / 5 years) x 4 years = $20,000. The tax savings from depreciation is equal to ($25,000 / 5 years) x 34% x 4 years = $2,720. Therefore, the tax adjusted book value is $25,000 - $20,000 - $2,720 = $2,280. The cash flow from disposing of the old machine is $12,000 - $2,280 = $9,720. However, there is a tax liability associated with the disposal. The tax liability is equal to the tax rate times the difference between the market value and the tax adjusted book value, or 34% x ($12,000 - $2,280) = $2,100. Therefore, the net cash flow from disposing of the old machine is $9,720 - $2,100 = $7,620. This is closest to option B, which is $9,620.

The Following Data Is Associated with a Proposed Replacement Project