Krugman Construction Company is considering the purchase of a new crane at a cost of $600,000. If the new crane is purchased the old crane will sold. It was purchased 5 years ago at a cost of $450,000. To date, the company has taken $200,000 in depreciation on the old crane. Compute the cash flow that would be realized from selling the old crane under each of the following scenarios. Krugman's marginal tax rate is 30%.
a. The crane is sold for $200,000
b. The crane is sold for $250,000
c. The crane is sold for $300,000
Answer:
a. Sale results in a loss of $50,000 ($200,000 - $250,000 undepreciated cost). The loss results in a tax shelter of $50,000 × .3 =$15,000. The company will realize $200,000 + $15,000 = $215,000 on the sale of the old crane.
a. Sale results in a loss of $50,000 ($200,000 - $250,000 undepreciated cost). The loss results in a tax shelter of $50,000 × .3 =$15,000. The company will realize $200,000 + $15,000 = $215,000 on the sale of the old crane.
b. There is neither a profit nor a loss on disposal of the old crane. Krugman will realize $250,000 on the sale of the old crane.
c. There is a profit of $50,000 on disposal of the old crane which will result in a tax liability of $50,000(.3) = $15,000. Proceeds from sale of the crane will be $300,000 - $15,000 = $285,000.
Kahnemann Kookies is evaluating the replacement of an old oven with a new, more energy efficient model. The old oven cost $50,000, is 5 years old and is being depreciated over a life of 10 years to a value of $0.00. The new oven costs $60,000 and will be depreciated over 5 years with no salvage value. Kahnemann uses straight line depreciation, its tax rate is 40%. If the old oven is sold for $10,000, compute the net cost of the new oven.
Answer: Annual depreciation on the old oven was $50,000/10 or $5,000 per year. Remaining depreciable value is $50,000 - 5($5,000) = $25,000. $10,000 - $25,000 = ($15,000). The loss on disposal of the old asset will result in a tax shelter of $15,000(.4) or $6,000. The net cost of the new machine is:
$60,000 less $10,000 from the sale of the old machine, less $6,0000 tax shelter = $44,000 net cost.
Kahnemann Kookies is evaluating the replacement of an old oven with a new, more energy efficient model. The old oven cost $50,000, is 5 years old and is being depreciated over a life of 10 years to a value of $0.00. The new oven costs $60,000 and will be depreciated over 5 years with no salvage value. Kahnemann uses straight line depreciation, its tax rate is 40%. Compute:
a. the change in annual depreciation that would result from purchasing the new machine.
b. the change in taxes each year that would result from purchasing the new machine.
Answer:
a. Annual depreciation on the old machine is $50,000/10 = $5,000 per year. Depreciation on the new machine, if purchased, would $60,000/5 = $12,000 per year. Depreciation expense would increase by $12,000 - $5,000 = $7,000 per year.
b. The increase in depreciation expense would lower taxes by $7,000(.4) - $2,800 per year.
