Question

Star-Lord Inc., a manufacturer of dance apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. Tax rate is 21%.

• New machine's purchase price is $150,000 with $16,000 additional installation cost.
• Old machine was purchased 2 years ago at $100,000 for total installed cost, depreciated over a 5-year MACRS schedule. There's a potential bid for $40,000 to purchase it.
• It will help decrease $30,000 in net working capital thanks to the improved efficiency.

How much is the after-tax proceeds from selling the old machine?

A.) 38,320

B.) 41,680

C.) 48,000

D.) 36,770

What is the initial investment for Star-Lord?

A.) 65,480

B.) 154,320

C.) 78,390

D.) 94,320

40 To reduce overall portfolio risk, it is best to diversify by adding to the portfolio, assets that have the/a ______ correlation with each other.

A.) Positive

B.) Zero

C.) Highest

D.) Lowest

Answer 1

Written down value of machine = Original cost – Depreciation for 2 years

= 100,000*(100-20-32)%

= $48,000

Selling price = $40,000

Loss on sale = $8000

Tax savings on loss = 8000*21% = $1,680

After tax proceeds = Selling price + Tax savings

= 40,000+1680

= $41,680

i.e. B

Initial Investment = Proceeds from old asset + Decrease in working capital – Cost of new machine – Installation cost

= 41,680+30,000-150,000-16,000

= -$94,320

i.e. D

D)Lowest

Lowest the correlation, lower will be the risk