Table 11.2
Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2014. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent.
________________________________________________________ *Not applicable
-For Proposal 2, the tax effect on the sale of the existing asset at the end of the fifth year results in ________. (See Table 11.2)

Question

Table 11.2
Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2014. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent.
________________________________________________________  *Not applicable
-For Proposal 2, the tax effect on the sale of the existing asset at the end of the fifth year results in ________. (See Table 11.2)

Quizplus · Accepted Answer

For Proposal 2, the sale of existing equipment at the end of year 5 will result in a taxable gain of $60,000 ($220,000 sale price - $160,000 adjusted basis). The tax liability on this gain will be 40% x $60,000 = $24,000. However, since this gain is being offset by the loss on the sale of the new equipment, the net tax liability will be $24,000 - $9,440 = $14,560.

The best choice(s) cannot be determined without knowing the firm's specific investment criteria and goals. Each proposal should be evaluated based on its net present value (NPV) using the firm's cost of capital as the discount rate. The proposal(s) with the highest positive NPV(s) should be chosen as they will add the most value to the firm.

Table 11.2 Computer Disk Duplicators, Inc. Has Been Considering Several Capital Investment