Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000. The current market value of the old machine is $18,000 but the book value is $32,000. The firm's tax rate for ordinary income is 30%. What is the net cash outflow for the new machine after considering the sale of the old machine? Disregard the effect of depreciation of the new machine if acquired.

Question

Quizplus · Accepted Answer

To determine the net cash outflow, we need to consider the cash inflow from the sale of the old machine and the cash outflow for the new machine after taxes.

Cash inflow from sale of old machine:

Market value = $18,000 
Book value = $32,000

Because the market value is less than the book value, selling the machine would result in a loss. The tax effect of this loss can be calculated as follows:

Loss on sale = $18,000 - $32,000 = $-14,000 
Tax savings = $-14,000 x 0.3 = $-4,200

The tax savings will reduce the cash outflow required for the new machine.

Cash outflow for new machine:

Purchase price = $70,000 
Tax savings from loss on sale = $4,200 
Net cash outflow = $70,000 - $4,200 = $65,800

Therefore, the net cash outflow for the new machine after considering the sale of the old machine is:

Net cash outflow = $65,800 - $18,000 = $47,800

The correct answer is A.

Firm X Is Considering the Replacement of an Old Machine