Table 11.3
Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset will be depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.
-The tax effect on the sale of the existing asset results in ________. (See Table 11.3)

Question

Quizplus · Accepted Answer

The tax effect on the sale of the existing asset can be determined using the MACRS Depreciation Table (Table 11.3). Since three years of depreciation have already been taken, the remaining depreciable basis is $25,000 - $11,250 = $13,750. The sale proceeds are $10,000, resulting in a loss of $3,750 ($10,000 - $13,750). This loss can be used as a tax write-off, resulting in a tax savings of $1,500 ($3,750 x 40%), which is subtracted from the tax liability. Therefore, the tax liability on the sale of the existing asset is $1,100 ($2,600 - $1,500), and the correct answer is C.

Table 11.3 Cuda Marine Engines, Inc. Must Develop the Relevant Cash Flows