Unformatted text preview: 35,000 $18,000) increase in net working capital. Both
ordinary income and capital gains are taxed at a rate of 40%.
The only component of the initial investment calculation that is difficult to
obtain is taxes. Because the firm is planning to sell the present machine for
$40,000 more than its initial purchase price, a capital gain of $40,000 will be
realized. The book value of the present machine can be found by using the depreciation percentages from Table 3.2 (page 100) of 20%, 32%, and 19% for years
1, 2, and 3, respectively. The resulting book value is $69,600 ($240,000
[(0.20 0.32 0.19) $240,000]). An ordinary gain of $170,400 ($240,000
$69,600) in recaptured depreciation is also realized on the sale. The total taxes
on the gain are $84,160 [($40,000 $170,400) 0.40]. Substituting these
amounts into the format in Table 8.2 results in an initial investment of $221,160,
which represents the net cash outflow required at time zero.
Installed cost of proposed machine
Cost of proposed machine
Total installed cost—proposed
After-tax proceeds from sale of present machine
Proceeds from sale of present machine
Tax on sale of present machine
Total after-tax proceeds—present
Change in net working capital $380,000
$221,160 Initial investment Review Questions
8–9 Explain how each of the following inputs is used to calculate the initial investment: (a) cost of new asset, (b) installation costs,...
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