Waterford Industries is considering the purchase of a new machine.It will replace an existing but obsolete machine that will be sold for $50,000.The existing machine is 8 years old,cost $200,000,had a 10-year useful life,and is being depreciated to zero using the straight-line method.Waterford's income tax rate is 35%.What is the after-tax salvage value of the old machine?

Question

Quizplus · Accepted Answer

To find the after-tax salvage value of the old machine, we need to first determine its book value, which is the amount of its original cost that has been depreciated. Since it has a 10-year useful life and is now 8 years old, it has been depreciated for 8/10 or 80% of its useful life. Therefore, its book value is 80% of its original cost of $200,000, or $160,000.

Next, we need to determine the tax impact of selling the old machine for $50,000. Since its book value is $160,000, Waterford will realize a taxable gain of $50,000 - $160,000 = -$110,000 on the sale. However, since this is a loss, it will actually result in a tax savings for Waterford of 35% x $110,000 = $38,500.

Therefore, the after-tax salvage value of the old machine is the sale price plus the tax savings, or $50,000 + $38,500 = $88,500.

The best choice is to replace the old machine with the new one, as the tax savings from selling the old machine is greater than the cost of the new machine.

Waterford Industries Is Considering the Purchase of a New Machine