AC 52 - Question You purchased a machine for $1.11 million...

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Question: You purchased a machine for $1.11 million three years ago and have been applying straight-line depreciation to zero for a seven-year life. Your tax rate is 38%. If you sell the machine today (after three years of depreciation) for $700,000, what is your incremental cash flow from selling the machine? Answer: Depreciation as per Straight Line method = (Purchase price - Salvage value) / Useful life ($1,110,000 - 0) / 7 = $158,571 Depreciation for past three years = $158,571 x 3 = $475,713 So, Book value of machine on date of sale that is today = Purchase price - Accumulated depreciation = $1,110,000 - $475,713 = $634,287 Gain on Sale = Selling price - Book value = $700,000 - $634,287 = $65,713 Tax on Gain = Gain x Tax Rate = $65,713 x 38% = $24,971 So, Incremental cash flow from selling the machine = Gain - Tax = $65,713 - $24,971 = $40,742 Question: Suppose that you are approached with an offer to purchase an investment that will provide cash flows of
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Unformatted text preview: $1,300 per year for 15 years. ³he cosT of purchasing This invesTmenT is $9,200. You have an alTernatve invesTmenT opporTuniTy, of equal risk, ThaT will yield 9% per year. WhaT is The NPV ThaT makes you indi²erenT beTween The Two optons? Answer: We have to compare the present value with cost of the investment for its suitability. The discount rate will be the return expected from another project that is 9%. Annuity factor for 15 years at 9% = [1 - (1+r)-n ] / r = [ 1 - (1.09)-15 ] / 0.09 = 8.061 So, Present value of $1,300 to be received each year for 15 years = Cash Flow per year x Annuity factor = $1,300 x 8.061 = $10,479 So, NPV = $10,479 - $9,200 = $1,279 So, the Investment should be made as it is generating more returns than the present investment at 9%....
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