Session 20 Solutions

Session 20 Solutions - Example Wharton Publishing needs to...

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Example Wharton Publishing needs to either overhaul or replace its drill press. The following information is available: Wharton’s income tax rate is 35%. And, its objective is to earn a return of 20%. 20,000 5,000 Expected Salvage value in 5 years 20,000 5,000 Actual Salvage value in 5 years 20,000 Current salvage value 40,000 70,000 Annual cash operating cost 40,000 Cost of overhaul 30,000 Current book value $100,000 $80,000 Purchase price, new New Machine Old Machine
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To simplify our analysis, we will assume that: a) The firm will depreciate the asset using the straight-line method, so the net book value at the end of the project equals the expected salvage value. b) The accounting depreciation and IRS depreciation schedules are the same. [In reality, most of the time they are not. In particular, the IRS uses an accelerated depreciation method known as the Modified Accelerated Cost Recovery System (MACRS)]. c) That firms cannot “rollover” gains/losses from the sale of old assets into the book value of new assets. This means that a gain/loss from sale when replacing an old asset with a new asset is always taxable at the time of the sale. (In reality, the IRS has specific rules that may not make the gain/loss taxable until the firm disposes of all assets of that kind.)
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Session 20 Solutions - Example Wharton Publishing needs to...

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