Vastine Medical, Inc.

, is considering replacing its existing computer system, which was

purchased 2 years ago at a cost of $325,000. The system can be sold today for $200,000. It is
being depreciated using MACRS and a 5-year recovery period (see Table 4.2, page 117). A new
computer system will cost $500,000 to purchase and install. Replacement of the computer
system would not involve any change in net working capital. Assume a 40% tax rate.
a. Calculate the book value of the existing computer system.
b. Calculate the after-tax proceeds of its sale for $200,000.
c. Calculate the initial investment associated with the replacement project.
Answer:

Initial Cash flow:

Cost of new project: (500,000)
Installation Cost: 0
Total Cost of New project (500,000)
Net proceeds from sale of old asset 182,400
Change in Net Working Capital 0
Initial Cash flow (317,600)

Additional Information for collecting answer

“Net proceeds from sale of old asset

Book value at time zero 325,000
But after two years its book value remains
325000*52% = 169,000 already depreciated
Remaining book value after two years= 3250,000-169,000
= 156,000
But selling at 200,000
Additional profit= 200,000-156,000= 44,000
Tax pay = 44000*40% = 17,600 paid tax
Total amount receive 200,000-17,600

Net proceeds from sale of old asset= 182,400 ”

Edwards Manufacturing Company (EMC) is considering replacing one machine with another.
The old machine was purchased 3 years ago for an installed cost of $10,000. The firm is
depreciating the machine under MACRS, using a 5-year recovery period. (See Table 4.2 on page
117 for the applicable depreciation percentages.) The new machine costs $24,000 and requires
$2,000 in installation costs. The firm is subject to a 40% tax rate. In each of the following cases,
calculate the initial investment for the replacement.
a. EMC sells the old machine for $11,000.
b. EMC sells the old machine for $7,000.
c. EMC sells the old machine for $2,900.
d. EMC sells the old machine for $1,500.

Initial Cash flow:

Cost of new project: 24000
Installation Cost: 2000
Total Cost of New project 26000
Net proceeds from sale of old asset 7760
Change in Net Working Capital 0
Initial Cash flow (18240)

“Net proceeds from sale of old asset

Book value at time zero 10,000
But after three years its book value remains
10,000* 71% = 7100 already depreciated
Remaining book value after three years= 10,000-7100
= 2900
But selling at 2000-2900
Additional profit= 8100
Tax pay 8100*40%= 3240 paid tax
Total amount receive 11,000-3240

Net proceeds from sale of old asset= 7760 ”

Russell Industries is considering replacing a fully depreciated machine that has a remaining
useful life of 10 years with a newer, more sophisticated machine. The new machine will cost
$200,000 and will require $30,000 in installation costs. It will be depreciated under MACRS
using a 5-year recovery period (see Table 4.2 on page 117 for the applicable depreciation
percentages). A $25,000 increase in net working capital will be required to support the new
machine. The firm’s managers plan to evaluate the potential replacement over a 4-year period.
They estimate that the old machine could be sold at the end of 4 years to net $15,000 before
taxes; the new machine at the end of 4 years will be worth $75,000 before taxes. Calculate the
terminal cash flow at the end of year 4 that is relevant to the proposed purchase of the new
machine. The firm is subject to a 40% tax rate.